UK Water – Making Waves

08 Jun 2023 / Corporate research

Executive summary

UK Water – making waves

  • Over the past year, UK utility share prices have been volatile, especially within the electricity sub-sector. The combination of the war in Ukraine and the associated impact of fluctuating gas prices, along with sharply higher inflation and the consequential rise in interest rates, have destabilised much of the sector. Indeed, most sector constituents have seen their share pieces fall (although not seriously), while Centrica, the UK’s leading gas company, has bucked the trend, with a near 50% rise over the past year, albeit from a very low base.
  • The two largest quoted water companies have announced their full-year results in recent days (the announcement of Pennon’s full-year results post-dates the compilation of this publication). The results of the two leading water stocks, Severn Trent and United Utilities, contained few surprises; but the latter’s revenues fell by over 2%. The impact of surging inflation has seen a sharp spike in those interest payments associated with index-linked bonds, a funding mechanism to which United Utilities, in particular, is exposed; consequently, its adjusted EPS for 2022/23 was negative.
  • Considerable interest also focused on two specific sector issues that have generated extensive media coverage of late: first, leakage levels, although still too high, are at least falling; secondly, the water sector generally is – eventually – recognising the controversy surrounding storm overflow issues. Disposing of untreated sewage into rivers is intended to be a concession in quite exceptional cases, but, in recent years, it has become commonplace, and Ofwat is adamant that, given the environmental harm that it undoubtedly causes, especially to water quality, such a situation cannot continue.
  • At the financial level, the lead-up to AMP8 is well under way, with business plans for the five-year regulatory period – beginning in April 2025 – being drafted. It seems clear that a substantial increase in capital expenditure will be prescribed; how this will be financed, given the pronounced impact on consumer bills, is far from clear.
  • As expected, full-year dividends for Severn Trent and United Utilities rose – both by 4.6%. These annual dividend increases are linked to movements in CPIH. As inflation falls, future dividend increases, despite the time lag, are expected to be pared back in nominal terms.
  • In terms of share price movements over the last five years, those of Severn Trent and United Utilities have risen by 38% and 29%, respectively. Both were “safe havens” for investors during the COVID-19 period, when many cyclical stocks plunged. By contrast, despite its rally, Centrica’s share price is down by almost 20% since late May 2018.
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