Water company shares on the march

As a string of water companies report their half-year results, Nigel Hawkins asks if they're keeping the markets happy

The stock market has had a difficult few months with the shares of several big-name stocks weakening due to lower dividend expectations.

With a sub-$50 per barrel oil price, real concerns abound about the capacity of Shell to avoid a long-term dividend cut.

Other FTSE-100 members, such as Billiton – hamstrung by much lower commodity prices and reduced Chinese demand – and Rolls Royce, following numerous profit warnings, may have to cut their dividends.   

On the water-front, however, there is abundant confidence that dividends can not only be maintained but actually raised in real terms.

As such, water company stocks have been very strong in recent days, aided not only by reassuring interim results from the three major quoted water stocks but also by persistent bid speculation – Pennon’s shares rose by over 5 per cent last Friday alone.

Of this trio, all of whom reported last week, Pennon’s results were the best received.

Underlying earnings per share (EPS) at 23.2p were up by 5%, whilst the interim dividend was raised by a healthy 4.8%.

The core water business is doing well, boosted by Pennon’s fast-tracking benefits in last year’s periodic review and the recently confirmed Bournemouth acquisition.

And, after various disappointments from its Viridian waste business, Pennon was able to report a sharp increase in its earnings before interest, tax and depreciation (EBITDA). The first half-figure last year was £55.3 million, whereas the comparable EBITDA return for 2015/16 was £90.9 million.

Much of this increase was due to new Energy Recovery Facilities (ERFs) coming on stream in recent months.

Severn Trent’s interim results were also robust, with underlying EPS – at 58.6p – being well above the market consensus; the year-on-year increase was 11.4%.

As flagged, the 2015/16 interim dividend was lower following the post-periodic review decision to re-base it – and allow higher growth going forward. 

Central to Severn Trent’s future performance will be its ability to out-perform Ofwat’s periodic review assumptions. Given that just a few months of the five years have already elapsed, it is somewhat premature to assess the likely level of out-performance.

However, Severn Trent’s share price is now comfortably above the bid price in summer 2013 that its directors – bravely – turned down. On current figures, they are being vindicated.

United Utilities’ share price has also sparkled. Its overall figures were solid, although EPS was down from 25.8p to 23.9p; the impact of the periodic determination was instrumental in this decline.

Certainly, compared with Pennon, United Utilities’ dividend growth outlook is less bright, although it will be striving to ensure that its dividend is at least maintained.

Of course, it has a formidable capital expenditure programme, as has been the case since privatisation in 1989.

And, on a more modest level, it will be pleased that bad debts for the first half of 2015/16, at £19.7 million, were down from the £23.1 million charged in 2014/15.

In terms of recent media coverage, United Utilities has featured prominently because of a cryptosporidium outbreak at its Franklaw water treatment plant near Garstang.

Whilst those affected were back on supply by early September, United Utilities has incurred various costs, mainly compensation to householders.

In its interim figures, it took a £24.8 million charge for this outbreak.

Whilst it would be disingenuous to dismiss water company interim figures as unimportant, they do reflect just the first six months’ of trading over a five-year regulatory period, during which the level of out-performance will be closely analysed.

Operating cost reductions will be key, along with the ability to deliver investment programmes within – and preferably below – budget. Both these elements lie at the heart of the totex regulatory process.

Aside from a positive dividend outlook, two other factors should not be overlooked.

First, the seemingly ingrained political uncertainty has been greatly eased by the election results last May.

Whilst it was the energy companies who were far more exposed to either a Labour majority government – or even a hung Parliament – the regulatory risk of water company investment would have risen.

Secondly, increased bid speculation, always a driver of water company share prices, could occur, despite the currently high premia against Regulatory Asset Value (RAV).

If so, shares in water companies would climb even further.      

Nigel Hawkins (nigelhawkins1010@aol.com) is a Director of Nigel Hawkins Associates which undertakes investment and policy research