The London Stock Exchange’s premier share index is packed with mature businesses that generate loads of cash. This gives them the confidence and the financial strength to reward their investors with above-average dividend payments.

Here are two FTSE 100 stocks I’d buy for a lifetime of passive income.

United Utilities Group

Buying utilities stocks can be a great way to generate long-term passive income. They have reliable profits irrespective of broader economic conditions.

This gives them (barring really exceptional circumstances) what it takes to pay big dividends year after year. As a consequence United Utilities Group (LSE: UU) has become one of the FTSE 100’s most reliable dividend growers.

Pleasingly City analysts are expecting further growth over the short-to-medium term too. This results in bulky yields of 5.3% and 5.8% for the next two fiscal years.

United Utilities provides water and wastewater services to around 7m people. It supplies services to three million households and 200,000 businesses.

My only concern with investing here is that the business operates under a strict regulatory regime. Adverse changes here can have a big impact on profits and on what it can return to shareholders.

Last week for instance regulator Ofwat slapped £150m worth of fines on 11 water companies. This was owing to them missing environmental targets. United Utilities avoided penalties but the news highlights the persistent danger of regulatory action.

Unite Group

By comparison, student accommodation provider Unite Group (LSE: UTG) has a much more chequered dividend history.

The business slashed the shareholder payouts following the outbreak of Covid-19. But having taken the pain it’s been raising dividends again as student numbers have returned.

City forecasters are expecting more healthy dividend growth for the next two years. This means that dividend yields sit at a healthy 3.9% and 4.4% respectively.

A vicious spike in Covid-19 cases and return of lockdown continues would sink profits at Unite again. But on balance I think the earnings outlook here is super robust.

The UK has been a popular destination with overseas students for centuries. This provides Unite with exceptional earnings visibility.

Encouragingly the number of pupils from abroad is rising particularly strongly today too. Official data shows that 600,000 foreign students enrolled in UK universities in 2020/2021. This was almost a full decade ahead of government targets.

Accommodation demand is particularly high amongst those from overseas. But pleasingly for Unite the number of homegrown students is also tipped to detonate in the years ahead. The Higher Education Policy Institute has said that “universities are set to see a significant rise in student numbers over the next 15 years.”

I believe Unite Group — along with United Utilities — is a great stock to buy for long-term passive income.

[Just beginning your investing journey? Check out our guide on how to start investing in the UK.]

Safestore Holdings

What it does: Safestore is a leading self-storage provider operating throughout the UK and Europe via a network of 179 locations.

By Zaven Boyrazian. Safestore Holdings (LSE:SAFE) is the UK’s largest provider of self-storage solutions, with 179 facilities around the UK and Europe. In total, the group has just over 7.6 million square feet of leasing space at an 84.3% occupancy rate as of July 2022.

While self-storage is hardly the most exciting sector, it provides a critical service that’s growing in demand and generally resilient to economic shifts.

So far this year, Safestore’s revenue has grown by a solid 15.6% overall and 12.8% on a like-for-like basis. Management has also been exercising a bit of pricing power to bolster its average storage rate by 9.1% to £28.59 per square foot. And with only a handful of fixed operating costs, net profit margins stand at an impressive 42.7%

Despite delivering consistently impressive results, shares currently trade at a dirt-cheap P/E ratio of just 3.9. Pairing this with a 3.1% dividend yield makes me believe a bargain income opportunity has emerged for my stocks and shares portfolio.

Zaven Boyrazian does not own shares in Safestore Holdings.

NatWest

What it does: NatWest is a banking firm based in the UK. It specialises in a number of products, including personal and commercial banking.

By Andrew Woods. For 2021, NatWest (LSE:NWG) paid a dividend of 10.5p per share. At the time of writing, this payment equates to a dividend yield of around 4.66%. Although that’s not the largest yield on the market, I still consider it to be solid.

The company has been benefiting from a trend of rising interest rates. Rates have risen to 2.25% in the UK and may well climb higher as central banks seek to bring inflation under control.

Higher rates basically mean that banks can charge more for borrowing services. However, since they make loans and mortgages more expensive, some customers may be put off taking on more debt amid the cost-of-living crisis.

Regardless, the firm posted an operating pre-tax profit of £2.6bn for the six months to 30 June. This was up from £2.3bn for the same period in 2021. For now, at least, the bank appears to be in a strong position and my income favourite at the moment.

Andrew Woods has no position in NatWest.

Endeavour Mining

What it does: The company owns and operates gold mines across Africa. It makes money by selling the gold it extracts.

By Stephen Wright. Shares in Endeavour Mining (LSE:EDV) just hit a price that I find it impossible to ignore them at. That’s why they’re my top British income stock for October.

As a gold mining company, Endeavour’s profitability is tied closely to the price of gold. The higher the gold price, the more money the business makes.

Recently, the price of gold has been coming down, falling from $1,756 per ounce to $1,643 per ounce. And the stock I’m looking at has fallen from £18.09 per share to £15.83.

To me, this looks like a good opportunity to buy shares. Over time, I expect the price of gold to increase and I expect all gold mining companies to benefit.

The reason for focusing on Endeavour specifically, though, is that it has lower costs than its competitors. This gives it an advantage that I think is extremely difficult to replicate.

Stephen Wright does not own shares in Endeavour Mining.

United Utilities Group 

What it does: United Utilities supplies water and wastewater services to 7m households in the North West of England.

By Royston Wild. I think buying classic defensive shares could be a good idea as stock market volatility picks up. One I’m thinking of snapping up in October is United Utilities Group (LSE: UU). 

The outlook for the UK economy is plagued with danger as inflation soars and interest rates rocket. But our essential need for water means that revenues at suppliers like this remain rock-solid.

As a consequence, businesses like United Utilities have the financial clout and the confidence to raise dividends at all times. Indeed, for the years to March 2023 and 2024 City analysts are expecting total payouts of 45.57p and 49.42p per share respectively. 

These are up from last year’s full dividend of 43.5p per share. And they provide healthy yields of 4% and 4.4%.  

I also like United Utilities because a lack of industry competition provides revenues with additional security. Though bear in mind that changes to water UK regulations could have an impact on future earnings.

Royston Wild does not own shares in United Utilities. 

Glencore

What it does: Glencore is the world’s largest commodity trader, known for trading metals that include the likes of zinc, copper, lead, and nickel.

By John Choong. Bucking the trend of the FTSE 100, Glencore (LSE: GLEN) has outperformed the wider index by more than 20%, at the time of writing. Pair that with a decent dividend yield of just under 5%, and the commodity giant certainly looks like a lucrative income stock to buy for my portfolio.

In its latest half-year results, Glencore smashed it out of the park by posting top line and bottom line growth of 43% and 820% respectively. While the outlook for metals is a rather uncertain one given the economic conditions surrounding a global recession, management believes that the reopening of China in the second half of the year could boost its income stream, and dividend as a result, while helping to hedge against declining metal prices.

Nevertheless, it’s worth noting that the miner’s dividend isn’t well covered by current earnings and cash on its balance sheet. So any substantial decline in metal prices and overall demand could significantly hamper the dividend payout. 

John Choong has no position in Glencore.

Smith & Nephew

What it does: Smith & Nephew is a medical technology company that specialises in hip and knee implants and advanced wound management.

By Edward Sheldon, CFA. Smith & Nephew (LSE: SN) shares have fallen in recent months due to challenges associated with supply chains, inflation, and China, and I think the share price fall has created an attractive buying opportunity for long-term investors like myself.

In the near term, the challenges I’ve mentioned above could persist. However, eventually, I expect them to moderate as the world returns to normal after the pandemic. And when they do, sentiment towards the healthcare stock should improve. It’s worth noting that, in many countries, there are large backlogs for joint replacement surgery.

Meanwhile, the long-term growth story here remains attractive. By 2030, one in six people globally will be 60 or over. This is likely to create strong demand for joint replacements.

With the stock currently sporting a P/E ratio that is not much higher than the average FTSE 100 P/E, and offering a dividend yield of about 3%, I think it’s a good time to be buying here.

Edward Sheldon owns shares in Smith & Nephew.

BAE Systems

What it does: BAE Systems is a defense, aerospace and security company.

By Paul Summers. Finding a high-yielding income stock isn’t hard right now. Then again, I think it still pays to be cautious. With a recession already here/on the way, many companies may reduce their cash returns or cut them completely. That’s why my pick is BAE Systems (LSE: BA).

Prompted by the invasion of Ukraine, its shares have been in fine form in 2022. This has reduced the yield to a pretty pedestrian 3.2%. Even so, payouts are likely to be covered twice by expected profit. This arguably makes the £25bn cap a relatively safe play for income hunters.  

At almost 16 times earnings, the shares trade at a premium to their five-year average. Hence, there might be some profit-taking on the horizon. However, I think this is a risk worth taking. BAE boasts a superb record when it comes to consistently increasing its annual payouts. 

Paul Summers has no position in BAE Systems

Fracking involves shooting a high-pressure mixture of water, sand, and other chemicals underground to crack rocks and release trapped gas and oil.

The technique has been used in the US since 1947 to produce 600trn cubic feet of natural gas. It was banned in the UK in November 2019 over fears it could generate earth tremors.

Drilling into the details

Already, well-positioned UK oil and gas companies have seen their stock prices rocket. AIM-listed exploration company Egdon enjoyed a stock price jump of 30% in the last month.

Another hydrocarbon explorer in the UK, IGAS Energy, has seen its stock rally by 460% since 2022 kicked off.

Both of these companies could continue to enjoy market-beating share price growth in coming months and years.

However, I won’t be buying either of them. Their remarkable 2022 gains signal to me that the upside has already been priced in.

Instead, I have been looking for a less obvious UK share that could benefit from Truss’ fracking re-start.

Location, location, location

The north-west of England, or more specifically Lancashire, is home to the UK’s only shale gas wells.

These were built by UK energy firm Cuadrilla, owned by Australia’s AJ Lucas Group, before the fracking ban of 2019.

Oil and gas exploration companies will now likely begin scouring the UK for more potential drilling sites.

History indicates the north-west of England is a fertile ground for such applications. Previously, requests to frack have been filed with local authorities in Cheshire, Manchester, and Warrington.

The so-called ‘Carboniferous Bowland–Hodder area’ in north-west England is one of only four areas in the UK that is considered to have shale gas deposits that would be commercially viable to extract.

Making a splash

Enter United Utilities Group (LSE:UU). It owns 114,000 acres of land in the north-west of England, used primarily to gather water for its reservoirs.

In 2013, United Utilities Group entered into talks with Cuadrilla to let them explore for fracking sites on its land. It is possible such talks could resume in the coming months or years. Yet United Utilities’ stock price slumped 10% over the last month.

I don’t think investors have cottoned onto this potential windfall for the water giant yet. Of course, I also need to consider United Utilities core business before investing my hard-earned capital.

It is concerning that United Utilities’ net debt burden of £7.7bn is 25 times bigger than the company’s free cash flow.

In addition, United Utilities saw its underlying earnings per share fall by 4% in 2021/22 due to the effect of high inflation pushing up payments on their massive, index-linked debt.

In the rising interest rate environment, I am put off from buying United Utilities Group shares due to its heavy debt load.

However, I wouldn’t be surprised to see the company enjoy a share-price pop if exploration companies approach it again about a drilling deal on its land in the next year or two.

Water provider

As a quick reminder, United Utilities is the UK’s largest listed water business. It supplies drinking water and wastewater services to 200,000 businesses and 3m domestic households in the North West region of England. It also has an electricity distribution arm as part of the business.

So what’s happening with United shares currently? Well, as I write, they’re trading for 1,119p. At this time last year, the stock was trading for 1,045p, which equates to a 7% return over a 12-month period.

FTSE 100 stocks have risks

The water industry, like many other utility industries, is subject to strict regulatory rules. This regulation could have an impact on profitability, returns, and investor sentiment. For example, United cannot decide to charge what it wants, it must abide by regulation when deciding whether to increase its bills and by how much.

Current macroeconomic headwinds such as soaring inflation, the rising cost of materials, and the cost-of-living crisis could impact performance and returns too. Many people are struggling to pay utility bills and this could result in United’s balance sheet being affected. The cost of maintaining infrastructure linked to water and wastewater assets is costly too and these costs could rise due to the current headwinds noted. I will keep a close eye on these developments but these issues are affecting many FTSE 100 stocks, not just United Utilities.

The bull case and what I’m doing now

So to the positives then. Firstly, I believe United Utilities shares have defensive attributes. This is linked to the fact that water is an essential staple and everyone requires it. Everyone has a water bill they must pay, which includes domestic customers and businesses alike. Demand should not cease, therefore, and this defensive aspect of the shares should boost performance and growth.

Next, I can see United has a good track record of performance. I do understand that past performance is not a guarantee of the future, however. Looking back, I can see it has recorded consistent levels of revenue and gross profit for the past four fiscal years in a row.

United Utilities shares would currently boost my passive income stream. Its current dividend yield stands at a healthy 4%. This is in line with the FTSE 100 average of 3%-4%. I am aware that dividends are never guaranteed and can be cancelled at the discretion of the business at any time, however.

Overall, I believe United Utilities shares could be a solid FTSE 100 stock to help me boost my passive income stream. For that reason I would add the shares to my holdings. I expect to receive consistent returns for the foreseeable future.

First I will look at why I think the shares might be rewarding for me – and then at the other side of the coin.

Why I might buy United Utilities shares

The common reason to buy utilities shares is because their dividends can offer healthy income streams.

United Utilities delivers on this. At the moment, the dividend yield is 3.9%. Although that is not as high as some other shares I already own, I do think it is still attractive enough for me to consider. If I put £1,000 into a share yielding 3.9% today and compounded the dividends annually, I could double my money in under 20 years if the share price remained steady.

Not only that, but I am optimistic that the company could grow its dividend in future. Growth last year was a measly 0.6% — but it was still growth. The dividend is covered by earnings. Dividends are never guaranteed, but the company has a stated policy of raising the payout in line with the growth rate of CPIH (the consumer prices index including owner occupiers’ costs) inflation each year through to 2025.

That is not exciting in the sense that in real terms it means the dividend will stay flat. But at least it is not a cut. CPIH has jumped – it was 8.2% in the 12 months to June. So I expect the next United Utilities dividend will show significant growth compared to last year.

Ongoing demand and limited competition for delivering utilities like water and sewage networks should help the company continue to generate substantial cashflows. But operating an aging infrastructure network can require heavy expenditure. Last year, I calculate that United Utilities actually had negative cash flows of £220, even before spending £296m on dividends.          

The bear case

Those cash flows concern me, because I expect further capital expenditure costs far into the future.

Another risk is profit margins. Like other businesses, United Utilities has to wrestle with wage inflation and other cost rises. But operating in a regulated industry, it does not simply have a free hand to raise costs as it likes. That could hurt future profitability.

Meanwhile, I do not see much of a long-term growth story here given the mature nature of the water industry. Nonetheless, the shares have moved up 22% in five years. I would be happy about that if I was a shareholder. I also think the dividend from United Utilities shares could be a handy source of income. It is not huge but it could still add up.

Overall, then, I think United Utilities do have the potential to be a nice little earner for me. But I see no reason to think they would help me get great, rather than simply nice, investment returns. So for now, I shall not be adding them to my portfolio.

But we also appear to be entering a period of stagflation, characterised by high inflation and slowing economic growth. This is even though the labour market is still running hot. It’s what I’ve seen called a ‘jobful downturn’.

So, I want stocks that can still perform well amid the current environment and provide me with sizeable yields.

Here are two stocks I’d buy now.

Centamin

Investors use gold as a safe haven when there are fears about inflation and the wider economy. So that’s why I’m looking at Centamin (LSE:CEY).

Most gold miners have done pretty well this year, but in April, Centamin reported a big fall in profits in 2021, hence the share price we see today.

The Jersey-registered miner said that full-year profits had halved on the back of forecast lower revenue and an impairment on assets in Burkina Faso.

But things are looking up. Gold prices have sustained this year, and they could go further if economic concerns grow.

The miner expects production to be between 430,000 ounces and 460,000 ounces. Centamin produced 415,370 ounces in 2021. In Q2 on 2022, gold production rose 11% year-on-year to 110,788 ounces.

Production costs are increasing and that’s a concern, but the company has recently transitioned to owner-operator mining in Sukari underground — Egypt’s largest gold mine. The transition should save the company around $19m a year from 2023 onwards.

Investments in expanding the Sukari mine should also help increase production in the years to come.

Centamin currently has an 8.6% dividend yield, which will help my portfolio fight back against inflation. Meanwhile, profits should increase if gold prices go up.

United Utilities

United Utilities (LSE:UU) is a defensive stock. It doesn’t offer a massive dividend at 4.4%, but it’s a reliable profit maker, because very few things are more essential than water. In fact, it is one of the ultimate defensive stocks.

This company provides water and wastewater services to Northwest England. And in return for providing an essential service, it’s allowed to make a reasonable profit on the water sold. The regulator, Ofwat, sets the prices. So revenue is somewhat pre-determined. After all, it’s in nobody’s interest for a company providing an essential service to be in trouble.

Debt is an issue here and servicing that debt could start eating away at profitability. But it doesn’t appear to be a big concern right now. United Utilities has a healthy balance sheet and more than £300m in free cash flow last year.

JP Morgan recently turned cautious on the water sector, but remained positive on United Utilities over its peers. JPM maintained its preference for overweight-rated United Utilities relative to competitor Severn Trent.

I think United Utilities looks like a good buy right now amid the forecast economic downturn. The group also said it would increase its dividend by the rate of inflation each year through to 2025.

That’s not to say that utilities firms are without risk. This particular FTSE 100 business fell this week as Ofwat announced it was expanding an investigation into the dumping of sewage into rivers.

Okay, the regulator’s probe hasn’t currently got United Utilities in the crosshairs, announcing South West Water will be investigated. However, there is some concern other operators could be pulled in and subjected to huge fines.

No share is without risk, of course. And in the case of United Utilities I think the benefits of owning the business outweigh the dangers. Ultra-defensive stocks like these are worth their weight in gold at times like these.

Oh, and today the company’s forward dividend yield sits at a fatty 4.4%.

Housing hero

Springfield Properties (LSE: SPR) offers the sort of all-round value that also makes it a top buy for July. For this financial year, its dividend yield sits at an excellent 5.2%. And on top of this the housebuilder trades on a forward price-to-earnings (P/E) ratio of just 6.7 times.

Any investor in Springfield needs to consider the impact that Bank of England (BoE) rate rises will have on future profits. Accelerating inflation means rates could keep increasing rapidly in what could be a blow to homebuyer demand.

However, I believe this threat is more than reflected in the Scottish homebuilder’s ultra-low valuation. It’s also my opinion that sales of newbuild properties will remain rock-solid as historically-low mortgage rates — helped by intense competition among Britain’s lenders — appear here to stay.

I also believe the end of Help to Buy next March won’t be a catastrophe for housing stocks like Springfield. New government schemes to keep buyer deposits on the low side has already been launched. Besides, potential homeowners can still use a Lifetime ISA, a product that provides the same advantages as Help to Buy.

Brick bonanza

Ibstock (LSE: IBST) is a big-yielding dividend stock I already own. I’m tempted to buy more in July too, given its exceptional all-round value.

Ibstock makes bricks so, like Springfield, it’s also vulnerable by BoE rate rises. A cooling housing market will naturally hit demand for its product. What’s more, it takes a lot of energy to make a brick so the business is under threat from soaring energy costs.

Still, it’s my opinion that the benefits of owning this FTSE 250 share offset the dangers. Britain will need to get building frantically over the next decade and more to meet demand. The National Housing Federation thinks 340,000 new homes are needed each year in England alone.

Ibstock is obviously well-placed to exploit this massive market opportunity. Yet I don’t think this is reflected by the company’s low share price. Today, it trades on a forward P/E ratio of 10.2 times. It also carries a 5.2% dividend yield at current prices.

Protecting my wealth

The war in Ukraine has been shocking to behold from a humanitarian perspective. Even so, the performance of the BAE System‘s (LSE: BA) share price does support the thesis that investing in a defence firm or two can offset damage done elsewhere in a portfolio. Recession or not, the world will always need protection from despots.

While there’s some choice available to me in this space, I’ve always liked the FTSE 100 giant for its income stream. Put simply, BAE has an excellent record of consistently increasing its bi-annual payouts. In fact, I’d say it’s long been one of the most reliable payers in the index.

So, what are the risks here? Well, there could be a period of profit-taking once the market (inevitably) recovers its confidence and investors’ penchant for growth stocks returns. A ceasefire in Eastern Europe could be another catalyst. Although a 3.4% dividend yield is more than adequate, I can also get a lot more income elsewhere in the FTSE 100 (albeit by arguably taking on more risk).

That said, I still rate BAE as a potential core holding for me in an income-focused portfolio. I wouldn’t necessarily expect more fireworks from the share price — a price-to-earnings (P/E) ratio of 15 already looks to be up to date with news. However, I’d argue that capital gains were never the priority here.

‘Essential’ FTSE 100 stock

Utility stocks are loved by many investors for their defensive properties. Regardless of what’s going on with the UK economy, we all need electricity, gas and clean running water. That’s why a FTSE 100 stock like United Utilities Group (LSE: UU) has some appeal.

United’s water and wastewater treatment works operate in the North West of England. It supplies 1.8bn litres every day, the majority of which comes from Cumbria and Wales. Interestingly, it’s the largest corporate landowner in England.

Again, no investment offers a nailed-on opportunity to make money. This could be particularly true for United as its stock already trades at 22 times forecast earnings. That’s despite a fairly sizeable fall in the share price recently.

The latter can be largely blamed on Chancellor Rishi Sunak’s announcement that energy companies would be hit with a 25% windfall tax. Investors may also fear that United could see some reduction in water usage as consumers attempt to trim costs.

On the flip side, the 4.7% yield offers some compensation in these troubled times. That’s clearly not enough to outpace inflation but it might provide some comfort. Like BAE, United also has an excellent record of growing its annual dividend year after year. If that doesn’t smack of ‘strong and stable’, I’m not sure what does.

And if I’m able to reinvest rather than spend these payouts, I stand to benefit even more from the ‘wealth-builder’ that is compound interest!

The FTSE 100’s winners and losers last week

Although the FTSE 100 added 2.7% last week, its constituents’ shares had widely dispersed returns — as I’d expect. Of 100 shares, 83 rose in value. These gains ranged from a mere 0.1% to a tidy 21.3%. The average rise across these gainers came to 5.8%. But it’s among last week’s losers that I’m searching for cheap shares.

At the other end of the scale lie 17 shares that declined in value last week. These declines ranged from just 0.8% to a hefty 13.8%. The average decline across all those losers was 3.1%. That’s 5.8 percentage points behind the wider FTSE 100 index.

Finding cheap shares among the fallers

For the record, these two stocks were among the three worst-performing FTSE 100 shares last week (#98 and #99 respectively).

As you can see, both shares dropped by at least 9% last week. And that’s largely because these companies — United Utilities Group and SSE (formerly Scottish and Southern Energy) — are energy utilities. On Thursday, Chancellor Rishi Sunak announced a 25% windfall tax on the excess profits of UK energy suppliers. As a result, shares in UK energy and oil & gas companies took a beating. But do either of these shares look cheap to me today?

I’d buy SSE today for its dividend yield

As regulated utilities, these companies’ earnings and profitability are strictly regulated by Ofgem, the UK’s independent Office of Gas and Electricity Markets. Although this restricts their business models and so on, it also means that both companies have reliable (and steadily rising) revenues.

As a veteran value investor, I’m more drawn to SSE’s shares than those of United Utilities. Currently, SSE stock trades on a modest price-to-earnings ratio of 7.2 and a bumper earnings yield of 13.8%. What’s more, its dividend yield of 4.9% is at least a percentage point higher than the FTSE 100’s cash yield. To me, these fundamentals suggest that SSE might be the better bargain of these two cheap shares.

Energy suppliers could face tougher times

Recently, energy producers and utility companies have become easy targets for politicians. But what starts out as a one-off £5bn windfall tax might eventually evolve into a higher permanent tax burden for these businesses. This would be bad news for the future earnings and dividends of these companies. Even so, I like the look of SSE as a good fit for my family portfolio, so I’d still buy these cheap shares today for their passive income!

What are water shares?

A water stock simply refers to shares of a company whose business is closely tied to the water industry.

Supplying fresh water to homes and businesses is only part of the equation. There is also the issue of removal and treatment of wastewater.

Understanding what water stocks are all about is effectively understanding the water cycle.

Each water company pays the Environment Agency (in England) and Natural Resources Wales to collect water from reservoirs, rivers and underground aquifers in their locale. Groundwater and surface water treatment works clean the raw water, making it safe to drink. A network of pipes and enclosed storage reservoirs ensure clean water is available on demand. A network of sewers and pumping stations collect waste water, which is cleaned at sewage treatment works. Finally, the treated water is recycled back into the water system (for which a consent fee is payable to the regulator).

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UK regulatory framework for water stocks

If you are serious about investing in water shares, then an outline understanding of the regulatory environment will make you a smarter investor.

The water industry was privatised back in 1989. Today, a complex body of governmental agencies manage or influence the 11 water and sewerage undertakers in England and Wales (a separate company exists in Scotland).

The table below sets out the key regulators together with a brief resume of their role:

Top water stocks in the UK

Of the 11 regulated companies providing water and waste services in England and Wales, three are listed on the London Stock Exchange:

Severn Trent

Severn Trent has two business divisions. For the year ending 31 March 2021, its core regulated business earned revenues of £1.7bn. The vast majority of that revenue (98%) came from Severn Trent Water, with the remaining coming from Hafren Dyfrdwy. Profit before tax came in at £452m.

Outside of its two regulated water businesses, the company also runs a Business Services division. Operating throughout the UK, it generates renewable energy from various sources, including anaerobic digestion, crop, hydropower, wind turbines and solar technology. This much smaller business generated revenues of £135m and profit before tax of £24m for the same period.

Like all water companies, Severn Trent saw water usage being severely impacted by the Covid lockdowns. It saw a significant decline in non-household consumption, which was partially offset by higher domestic usage. Consequently, profit before tax was 17.1% lower than the previous year.

However, in its half-year results to November 2021, the company reported that consumption patterns have begun to return to pre-Covid levels. Consequently, revenues for this period were up 8% and profit before tax 10%.

Severn Trent’s dividend policy is to grow it year-on-year by at least CPIH (the ONS’s preferred measure of inflation) through to 2025. This is less generous than its previous policy of inflation plus 4%.

United Utilities

For similar reasons to Severn Trent, United Utilities’ revenue and profit were down 2.7% and 45% respectively for year ending 31 March 2021.

Throughout AMP7, the company is intending to accelerate its investment strategy to become a digital utility. Through its systems thinking approach, it wants to make better use of technology, automation and machine intelligence to drive operational and environmental performance. For example, it intends to install a total of 20,000 state-of-the-art sensors to its assets by summer 2022. This will enable it to improve, among other things, flood performance as well as gain greater insight into the whole-life of its assets.

As it has so far exceeded Ofwat’s customer outcome delivery incentives (ODIs), it has earned a bonus of £21m. This reward will be reflected in FY 2022/23. It has earmarked a cumulative outperformance payment of around £150m through to 2025.

United Utilities’ dividend policy is identical to that of Severn Trent.

Pennon

As the smallest of the three companies, Pennon is listed on the FTSE 250. However, it still faces similar challenges and opportunities to its two larger peers.

Two key milestones need to be mentioned in relation to this firm. Firstly, in 2020 it sold Viridor (a UK-wide waste management company) for £3.7bn to a private equity consortium. The £1.7bn profit it made from this sale was distributed to shareholders by way of a special dividend together with a share buyback programme.

Secondly, in June 2021 it bought all the issued share capital of Bristol Water for £400m. The deal is expected to add 16% to its regulatory capital value (a key metric used by Ofwat for setting price limits for every price review period) going forward.

Like its peers, Pennon has a progressive dividend policy, which will grow in line with CPIH plus 2% per annum through to 2025.

Are water stocks right for you?

In return for being a monopoly business, each water company is heavily regulated. Consequently, they each face similar challenges. It is important that you are aware of these before making any investment decision.

• Large debt on the balance sheet – The water industry involves huge capital outlays, often requiring planning decades in advance. Whilst interest rates have remained low, servicing the debt was not a problem. But with rising inflation, interest rates are starting to creep up. With some of this debt index-linked, that is likely to put a strain on their balance sheets in the following years.
• A tougher regulatory environment – Through 2020-25, Ofwat has rebased the tariffs each can charge under the price review and raised the bar with regard to performance targets. In their latest annual reports, each company highlighted that turnover had been impacted as a result.
• Bad debt – The Water Industry Act 1991 (as amended by the Water Industry Act 1999) prohibits the disconnection of a water supply and the limiting of supply as a means of enforcing the payment of an outstanding bill. This is a unique challenge for the industry. Although each company has a robust debt management strategy in place, with an unfolding cost of living crisis hitting many households, revenues could get squeezed in the following years.

To summarise, water shares are the classic defensive stock. During the Covid-19 crash of 2020, their share prices fell nowhere near as heavily as the wider index. They have reliable, highly visible income streams with a progressive dividend policy (although, of course, no dividend is ever guaranteed). As with any stock, water shares can be volatile. But as demand for water continues to increase, water stocks remain one of the most favoured shares amongst pension funds and income chasers alike.

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