Analysis: Solid water interim results

The three listed privatised water companies have all reported their six-monthly results, and for the most part they justify the reputation of utility stocks as safe havens. By Nigel Hawkins.

Nigel Hawkins, director, Nigel Hawkins Associates Nigel Hawkins, director, Nigel Hawkins Associates

The three quoted privatised water companies – Pennon, Severn Trent and United Utilities (UU) – have all just published interim 2016/17 results. There were no surprises; hence the muted stock market response. Nonetheless, there are various issues which merit comment.

In terms of underlying earnings per share (EPS), Severn Trent reported the highest increase, up 13.5 per cent, with a sharp fall in financing costs. Pennon, which now incorporates Bournemouth Water, confirmed a more modest 1.7 per cent increase in underlying EPS – an improved performance from Viridor was a key factor. However, UU’s underlying EPS fell from 23.9p to 22.2p, due mainly to higher interest costs as the impact of substantial inflation-linked funding kicked in.

Encouragingly, all three companies were able to report lower underlying operating costs, as the search for efficiencies bore fruit.

Nonetheless, for UU in particular bad debt remains a challenge, even though the latest figures show that its non-payment ratio has fallen to below 3 per cent of regulated income.

During a period of widespread concern about the durability of dividend streams, the three water companies provided reassuring news. Indeed, Pennon undoubtedly out­performed on the dividend front, by delivering growth of RPI+4 – its confirmed policy until 2020. Severn Trent and UU announced dividend increases of a more modest 1.1 per cent, which is in line with expectations.

Ever-rising capital expenditure remains the norm, with UU projecting an £800 million full-year capital expenditure outturn. Severn Trent’s more modest half-year outlay totalled £235 million, while Viridor’s £104 million was more than half of Pennon’s total investment for the six-month period.

Given these numbers, it is hardly surprising that UU gives the highest priority to delivering its investment budget efficiently – and employs sophisticated engineering techniques to do so. While the £200 million Davyhulme wastewater scheme is key, UU’s most expensive project is its 100km West Cumbria pipe-line. Final planning approval has just been received for the £300 million scheme.

Although the core net debt to regulatory asset value ratios all remained within the 57-62 per cent band, Pennon reported a rise in net debt to over £2.5 billion, mainly due to increased investment by Viridor. Similar comments apply to UU, whose net debt is now a formidable £6,477 million compared with £6,261 million at March 2016. A substantial part of this net debt is funded by index-linked bonds, which bear various risks during periods of rising inflation.

In preparation for the opening up of the water market, especially at the business level, several initiatives have been launched. Two of the biggest water sector hitters, Severn Trent and UU, have set up a joint venture, the Stoke-based Water Plus, to tackle the UK business market. In Pennon’s case, its core water business partners are South Staffs and Cambridge Water, both one-time statutory water companies. Although some high-profile customer wins may be announced by all three companies, the impact on the bottom line may well be quite modest.

In terms of energy, the three are continuing to participate, albeit at different levels. In Severn Trent’s case, around 35 per cent of its energy requirements are now met by its own generation; this figure is set to reach 50 per cent by 2020. However, there seems minimal chance of Severn Trent becoming a more serious energy player, despite its all-embracing water retail franchise throughout the Midlands.

UU believes that improved sludge digestion technology can play a key role in delivering energy savings. Moreover – and rather oddly perhaps for a Lancashire-based company – UU has drawn up plans for heavy investment in solar power.

In the early 1990s, Pennon’s predecessor, South West Water, identified the waste sector as its prime non-core investment. Over the subsequent 20 years or so, it has expanded greatly, with its subsidiary Viridor now recognised as one of the UK’s leading waste businesses.

Currently, it operates eight energy recovery facilities with a further four to come. In particular, the planned Avonmouth plant, which will cost more than £250 million, will be pivotal. It is due for completion in 2020/21.

In recent months, many leading FTSE-100 companies have faced searching questions about their soaring pension deficits. Indeed, the issue of Severn Trent’s pension fund dominated the question and answer session at its recent analysts’ meeting. Under IAS 19, its reported deficit was £712 million, more than double the £310 million just six months previously.

Pennon’s pension deficit also rose sharply. By contrast, UU reported a £215 million pension surplus.

Otherwise, the three water companies’ results were rather boring – something that utility investors generally welcome.

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