Water utility stocks to watch as we head towards polling day
01:00, 01 mai 2015
· Av CMC Markets
The water and utility sector is another sector that could be subject to the vagaries of the parties manifesto commitments.
Once again it is the Labour Party manifesto that requires the most scrutiny given that the water companies are likely to also feel the heavy hand of government interference in terms of regulation and pricing, and could have significant implications for future dividend payments to pensions funds and small investors as well as future investment spending.
According to their manifesto -“One in five people struggle to pay their water bill. Despite this, only a fraction of customers have benefited from the social tariffs offered by water companies."
This is why the outcome of the 2015 General Election could have a significant impact on the way a significant number of UK listed companies do business in their respective markets. This is important in light of recent well-publicised pledges by the political parties, but Labour in particular to change the way these companies do business in their respective sectors.
The water market is likely to be one of those sectors affected:
Water Utilities - according to the Labour manifesto the water industry, also requires reform. “One in five people struggle to pay their water bill. Despite this, only a fraction of customers have benefited from the social tariffs offered by water companies.
Under Labour reforms “all water companies will be required to sign up to a new national affordability scheme, helping those who cannot afford to pay their water bill”. Labour has also pledged to “strengthen the powers of the regulator to change licenses, limit price rises and enforce industry standards.”
Again here the importance of future infrastructure spending, along with the sustainability of the dividend is likely to be a key factor in the company’s growth plans.
Severn Trent, current dividend yield 3.7%, headquartered in Coventry the company supplies nearly 4m households in the Midlands area around Birmingham and Nottingham, and some parts of the South West, including Cheltenham, Gloucester and Tewkesbury.
The company, along with the rest of the sector has to agree its pricing plan for the next five years with Ofwat the water regulator, at the same time formulating a plan to improve investment into an industry that consistently gets criticised for its leakage rates, and supply interruptions. Ofwat wants all firms to accept lower returns to help ease the strains on household finances.
With a healthy dividend any agreement that limits the company’s ability to maintain its cash flow could well bring the share price sharply lower from the recent multi year highs we saw earlier this year, particularly given that the dividend cover is on the low side at 1. With a final settlement due in December this year, any politically motivated intervention between now and then could well alter the risk profile to a sector that offers a consistently high dividend.
Pennon, current dividend yield 3.5%, headquartered in Exeter, Devon, and the company’s main water asset is South West Water. The company also owns a waste management and recycling business Viridor.
Unlike Severn Trent the company has had its 5 year spending plan approved by Ofwat which removes a great deal of uncertainty around its future investment plans.
The recent removal of £25m worth of costs at South West Water appears to have assuaged concerns about the dividend, but given a weak performance from its waste management unit Viridor, there is a risk that political interference in the water side of the business could prompt a reassessment and potential sale of the unit to preserve the dividend attraction.
The dividend cover currently comes in at 1.4, but could be vulnerable to some slippage.
United Utilities, current dividend yield 3.7%, headquartered in Warrington, is the UK’s largest listed water company, formed out of the merger between North West Water and NORWEB, and serves the North West of England.
The company finally agreed its next 5 year spending plan with Ofwat at the beginning of this year as it looked to raise bills so that it could boost spending to the tune of £3bn as it looks to update and improve the regions waste and sewerage infrastructure. The current dividend cover here is also on the low side at 1.2, and if margins come under pressure there is a risk that the dividend could well do so as well.
In conclusion, the utilities sector has traditionally been a fairly stable sector in terms of dividend growth in the past few years, and the share price performance has reflected that. A fairly stable regulatory framework has also helped, with speculation surrounding potential take-over bids never that far away.
This stability could well come under threat of government interference disrupts the price agreements already made between the regulator and the industry.
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