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Water utilities gain dividend clarity

Utility companies including United Utilities and Severn Trent have gained greater certainty over their revenue streams after receiving their final determinations from Ofwat.
December 18, 2014

United Utilities (UU) and Severn Trent (SVT) gained a clearer vision of their business plans last week after Ofwat released its final determinations. The water regulator’s proposals determine prices utility companies can charge consumers and provide detail on the regulatory framework for the next five years.

Analysts expect Severn Trent and United Utilities to announce their updated dividend policies within the next two months. Pennon Group (PNN), owner of South West Water, was the clear winner of the process after receiving enhanced status from the regulator. This meant it received its draft determination in April and its business plan was unchanged.

But United Utilities defied expectations the most. The group had been concerned about the significant gap between its estimates for spending and Ofwat’s. Total expenditure for the group’s wholesale wastewater business plan had been £769m more than that suggested by the regulator in its draft determination, coupled with a £215m gap for the water segment. But this gap has now shrunk to £179m and £9m respectively. Analysts at Deutsche Bank had expected a gap of £330m following the final determination. Shares in the group rose by almost 4 per cent following the announcement.

Ofwat has also reduced the allowed return on capital to 3.74 per cent from 3.85 per cent during the current regulatory period. However Pennon’s enhanced status means it is unaffected by the change in the costs of capital. This was broadly in line with the 10 basis point reduction expected by Deutsche Bank.

However this reflects investors’ lower return expectations from low-risk stocks, since the allowed return on capital was set for the current regulatory period in 2009, analysts said.

The determinations provided for a 3 per cent cut in bills over the next five years for United Utilities and 5 per cent for Severn Trent. This is compared with 7 per cent and 5 per cent expected respectively by analysts at Deutsche Bank. Analysts at the bank have both United Utilities and Severn Trent on a buy rating since they generate attractive returns given their low risk nature.

Angelos Anastasiou, utilities analyst at Whitman Howard, has United Utilities and Severn Trent on a hold, since he believes much of the historic increase in share prices is due to takeover speculation. He said: “If you were just looking at the underlying returns as a UK investor, the share prices would be lower.”