Reasons to tighten the tap on water dividends

This week we look at three very different stocks. First, a specialist fund manager that has been dragged under by its focus on an unpopular market sector. Second, a specialist property company in self-storage, an industry that potentially faces a much tougher outlook after being a major winner during the pandemic. Finally, we have a water utility company.

The water industry faces a lot of pressure to perform much better while potentially needing to take on more debt, come to the equity market for funding and even to reassess the affordability of once rock solid dividend streams. 

Ashmore (ASHM)  – this is a specialist emerging markets fund manager that has suffered from both very volatile market performance and a sizable withdrawal of funds in the last three years. This has sharply eroded the profit base, leading to a substantial de-rating and underperformance. However, interest in emerging markets may now have turned the corner with improving momentum in the flow of new funds. While earnings upgrades remain speculative, Ashmore offers a high yield (8½ per cent) that, for various reasons, looks well underpinned. Either through the yield or earnings upgrades reversing the negative share price trend, there is scope for investors to make a high single digit total return.  

Big Yellow (BYG) – self storage has been a booming market since the start of the pandemic but into the current economic headwinds, can that momentum be sustained? Renting self storage is relatively expensive (c.£1,000 per annum) and with households cutting back, storage risks looking like a vulnerable, discretionary item. As self-storage (even though its stocks are REITs) is an active operating model rather than a passive investor model, higher voids and more active churn will impact on the valuation as they hit profitability. Unlike other REITs one must value BYG on a PE rather than a price-to-book basis and, after the recent fall, the shares look to be trading at fair value (meaning in this case that there is no rush to buy). 

United Utilities (UU) – water companies are under the cosh largely due to their consistent inability to keep raw sewage out of the nation’s waterways. This is just one of a range of issues to be addressed when the next 5 year investment cycle (known in this industry as AMPs) kicks off in 2025 but the question is who is going to pay for it all? The industry wants steep increases in water bills but Westminster (both colours) is unlikely to tolerate that, especially amid a cost of living crisis and mortgage squeeze. The risk is UU and its peers are likely to need to issue a lot more debt and/or equity that may prove expensive and difficult to secure looking at Thames Water’s current travails. There is also likely to be pressure on the sector’s once very reliable (and often indexed) dividends. Also, is it time to take a look at the quirky and pretty arbitrary way that equity in this sector is valued?