Picturesque Windermere is a favourite haunt of wild swimmers. Reports of sewage pouring into its waters sends them off the deep end. The problem riles investors too. United Utilities, the rainy North West’s water authority, has a quarter more sewer overflows than average. The government has demanded more than £14bn of investment to address the problem.
Water pollution is a big issue in the UK, as it was during London’s Great Stink in 1858. Sewage discharges now head a list of complaints also including high leakage rates and opaque finances. Campaigners, politicians and media are increasingly hostile.
Regulated monopolies like United Utilities tend to be steady earners. True to form, the company said revenues would be only 1 per cent lower than guided. Inflation will take a toll despite inflation-linked revenues. The utility is a heavy user of index-linked debt. Its net finance costs will be 6 per cent, or £10mn, higher than last year.
The valuation of water utilities is in line with the historical average, at a premium of 15 per cent to adjusted regulatory capital value. Yet the political risks of investing are rising. Politicians have responded to public anger by threatening fines of up to £250mn, a 1,000-fold increase. Water companies will have to prepare better for droughts. They need to spend an estimated £20bn on cutting leaks and reducing usage.
Water meters are part of that drive. About half of households have switched, in some cases compulsorily. But meters also make it harder for water companies to increase bills to pay for necessary investment. The average bill per household would need to rise by a daunting 60 per cent in real terms, to £700 a year, to cover the £100bn of capital expenditure required across the industry, according to Barclays.
The cost of curbing sewage spills comprises £56bn of that figure. The Great Stink was remediated with new sewers still serving that purpose today.
Water companies may need to raise new equity and splurge retained earnings. That will focus attention on dividends. Payouts extracted via expensive loans from shareholders will receive unwonted scrutiny.
As bond proxies, utilities have attractions. But amid a second Big Stink, investors should weigh up growing political risks before taking the plunge.
The Lex team is interested in hearing more from readers. Please tell us what you think of UK water utilities in the comments section below.
