Risks rising for United Utilities

In recent weeks, sewage has been in the news almost as much as our rivers. Earlier this month, reports of the near-constant discharge of wastewater in UK waterways culminated with the launch of a probe by the Environment Agency and Ofwat.

This backdrop matters to United Utilities (UU.), which supplies water to 3m homes and 200,000 businesses in the North West of England. The company can point to seven years without a serious incident and its largest ever drop in pollution in the half year to September, but local reports make clear that even overflows permitted during heavy storms are of growing public concern.

Addressing the issue could become tougher. Since 2000, United has spent £1.2bn to reduce overflow and spillage, during which time £6bn has gone on dividends. Another £6bn has serviced a debt pile whose size presents the largest obstacle for any future administration intent on re-nationalising the sector.

As such, water stocks like United retain strong defensive qualities, even if an 11 per cent average annual return over the last decade (assuming dividends are reinvested) suggests the shares offer much more than their reputation as a bond proxy.

Then again, a scan through the most likely and impactful risks is enough to doubt continued equity growth. These include the monumental challenge of decarbonising water by 2030, absorbing the outcome of Ofwat’s price review in 2024 and the potential failure of the ageing Haweswater Aqueduct.

Against this, half-year numbers suggest rising inflation and energy prices are being managed. But throw in possible rising interest rates and we think risks to consensus full-year dividend forecasts of 43.8p, 45.3p and 46.4p for 2022 to 2024 are increasing. Hold.

Last IC View: Hold, 865p, 22 May 2020