Water company financial results:the calm before the storm

The water companies’ interim results held no great surprises, but the sector’s attention is mainly focused on Ofwat’s publication next week of its final determinations, says Nigel Hawkins.

Like Banquo’s ghost in Shakespeare’s Macbeth, Ofwat’s final determinations – due on 12 December – overshadowed the publication of the water sector’s interim results. In the event, there were no major surprises for the three quoted water stocks, although Pennon’s share price did rise by more than 5 per cent on the basis of a distinctly more upbeat outlook for its troubled Viridor operations.

Aside from the unquoted Thames, most water sector attention on 12 December will focus on United Utilities and to what extent Ofwat has responded to its vigorous representations on future sewerage investment.  

At its interim results presentation, United Utilities’ chief executive, Steve Mogford, confirmed there was a £628 million gap in its five-year total expenditure figures “which, we believe, are not accounted for in Ofwat’s model”. Significantly, the implementation of Ofwat’s ‘upper quartile’ efficiency assumption has been a material factor in creating this formidable gap. Otherwise, United Utilities’ interim results were in line with expectations.

Revenue, at £859 million, and under­lying operating profit, at £343 million, were marginally up on the first half of 2013/14, while adjusted earnings per share (EPS) rose by 4.5 per cent from 24.7p to 25.8p. The interim dividend increased similarly, to 12.56p per share.

Net debt at September 2014 stood at almost £5.7 billion, compared with £5.5 billion in March 2014. However, United Utilities’ core business gearing figure of 57 per cent – based on net debt over its regulatory capital value (RCV) – was at the lower end of Ofwat’s preferred ratio.

Bad debts due from customers, which in total were almost £5 million higher in this year’s interim figures, are more of an issue.

Importantly, United Utilities has negotiated an exceptional £19 million a year adjustment with Ofwat, which takes account of higher than average social deprivation levels in its supply region, especially in industrial Lancashire.

Severn Trent’s interim results were solid, with a pronounced rise in underlying EPS of 12.6 per cent. This was due to several factors, including improved returns from Severn Trent Services and a £6.5 million finance cost saving.

Interim revenues at £948 million were up by 2.7 per cent, while the 33.96p interim dividend increase represented a 5.6 per cent rise compared with 2013/14.

Like United Utilities, Severn Trent’s core business gearing is at the lower end of Ofwat’s financing targets, with a net debt/RCV ratio of 57 per cent: its latest RCV figure is £7.7 billion. Severn Trent’s overall net debt is now just below £4.4 billion, 99 per cent of which relates to the core water business.

Given its comparatively low prices, it was hardly surprising that Liv Garfield, Severn Trent’s new chief executive, said she was “confident of maintaining the lowest combined bills for the next five years”.

Clearly, if the controversial £4.2 billion Thames Tideway project proceeds, this should be comfortably achieved.

For investors, Garfield confirmed that Severn Trent will set out its future dividend policy next spring: Ofwat’s final determinations will be crucial in this respect.

Furthermore, given that Severn Trent’s board bravely turned down a £22 per share bid in the summer of 2013, potential bidders will also be sizing up its financial capacity to pay enhanced dividends.   

Pennon’s interim figures were affected by the challenges facing Viridor, which – according to chairman Ken Harvey – has reached an inflection point. He forecast earnings before interest, tax, depreciation and amortisation of around £100 million in 2016/17 – a figure welcomed by the market.

As expected, returns from Viridor’s landfill, recycling, collection and landfill gas-power generation businesses were all down, due to lower prices but more especially notably higher costs. Viridor’s contribution at the profit before interest and tax level fell from more than £23 million to £8.2 million.

Hence, despite a solid core water performance, Pennon’s interim adjusted EPS fell from 23.8p to 22.1p. Nonetheless, the interim dividend rose by 6.3 per cent to 9.98p per share, while group net debt was £2.1 billion.   

In fact, as Ofwat’s sole privatised fast-tracker, Pennon’s core water business is in good shape. No doubt, Ofwat liked, too, its 3.8 per cent average financing cost – a figure below that of many other water companies.

Having secured fast-tracker status, Pennon’s regulatory settlement is more clear-cut than others; it is also receiving an £11 million boost to its RCV, which is now just less than £3 billion.

Sector bid speculation has already begun and will assuredly develop further once Ofwat’s final determinations are disclosed.

All three quoted water companies remain bid favourites, with a real expectation that Severn Trent may well be the subject of a renewed offer at a similar price to the 2013 rejected offer.

Nigel Hawkins, director, Nigel Hawkins Associates