For most shares in the FTSE 100, 2013 was a good year and investors have likely enjoyed capital gains and rising dividend income.
That makes me nervous about investing for 2014 and beyond, and I’m going to work hard to adhere to the first tenet of money management: preserve capital.
To help me avoid losses whilst pursuing gains, I’m examining companies from three important angles:
- Prospects;
- Risks;
- Valuation.
Today, I’m looking at regulated water and sewage utility provider United Utilities Group (LSE: UU).
Track record
With the shares at 653p, United Utilities Group’s market cap. is £4,453 million.
This table summarises the firm’s recent financial record:
| Year to March | 2009 | 2010 | 2011 | 2012 | 2013 |
|---|---|---|---|---|---|
| Revenue (£m) | 2,427 | 1,573 | 1,513 | 1,565 | 1,636 |
| Net cash from operations (£m) | 737 | 802 | 576 | 560 | 631 |
| Adjusted earnings per share | 26.5p | 50.8p | 35.1p | 35.3p | 39.1p |
| Dividend per share | 32.67p | 34.3p | 30p | 32.01p | 34.32p |
1) Prospects
To make sense of United Utilities’ recent financial performance it’s worth knowing that the firm completed a divestment programme in 2010. From 2011 onwards, the business emerged in its current form, and the decision to sell off its gas, electricity and other business interests has focused the firm on the core activity of being a regulated water utility provider.
United Utilities’ regulated water and sewage operations serve around seven million people in North West England and the company reckons it’s on course to invest more than £3 billion in its water and wastewater infrastructure between 2010 and 2015. It’s a vast network with over 42,000 kilometres of water pipes from Cumbria to Cheshire, around 76,000 kilometres of sewers, 569 wastewater treatment works, 94 water treatment works, and about 56,000 hectares of catchment land.
The opportunity for United Utilities is that renewed focus and targeted investment can improve financial and operational efficiency by such actions as renewing worn-out pipes to reduce leakage. As well as providing a better customer experience, reinvestment helps the firm with regulatory compliance. Compared to the year-ago figures, the recent half-year results showed regulatory capital expenditure up 15% to £407 million, underlying operating profit up 9%, and the dividend up 5%, so there’s evidence that the company’s strategy is benefiting shareholders, too.
2) Risks
However, it’s a capital-intensive business and the firm expects to invest a further £800million in its network this financial year. To help support such on-going capital expenditure United Utilities carries a large net debt burden – almost ten times operating profits, up from about 8.7 times operating profit two years ago.
Of course, the firm’s geographically captive customer base ensures consistent cash flow to help manage interest payments, but debt is debt, whichever way you look at it, and escalating regulatory demand could further pressurise debt levels going forward. In today’s world of ever-higher regulatory standards, that makes me nervous about the eventual outcome for United- Utilities-Group investors.
3) Valuation
The main attraction for investors here is surely the dividend and, on that score, the forward yield is running at about 6% for 2015. City analysts expect forward earnings to cover that dividend about 1.2 times, which means the firm is returning as much as it can to investors through the dividend.
Growth, then, is implicitly not the name of the game, so I think the forward P/E of about 14 is running a bit rich for the 6% earnings growth expected. That makes me concerned about the share price, as any P/E compression could nullify investor dividend gains.
What now?
I’m unlikely to invest in United Utilities Group for 2014 and beyond, but I can see how that dividend payment might be attractive to others.