To say that the performance of shares in water company United Utilities (LSE: UU) has left a lot to be desired over the last year is putting it mildly.
Priced at the £10 mark exactly one year ago, the shares were down 35% before this morning’s pre-close trading statement as a result of concerns over increased regulation and rising inflation.
Based on its contents — and the market’s fairly uninspired reaction — I’m not sure the stock will be bouncing back any time soon.
United we fall
According to the £4.5bn cap, current trading is in line with expectations. Thanks to higher charges permitted by Ofwat, group revenue is predicted to come in “slightly higher” than in the previous financial year with underlying operating profit also expected to be “moderately higher than 2016/17“. So far, so adequate.
Unfortunately, higher retail price inflation has continued to increase the company’s index-linked debt (which it has quite a bit of compared to industry peers), which in turn hits earnings. It now expects the underlying net finance expense to be “around £40m higher” than in the previous year. There will also be a “small increase” in net debt as a result of ongoing investment in its asset base.
Factor-in political concerns and the forthcoming review of water price controls by Ofwat and the investment case for United Utilities becomes still less attractive. That’s even if — as far as the latter is concerned — the company reflected that it is “confident” on being about to deliver against the water regulator’s key themes relating to “great customer service, affordable bills, innovation and resilience“.
Some may point to the near 6% yield and the resilient nature of utility companies, particularly when markets get choppy. While I don’t deny that the dividends on offer are tempting, it’s worth drawing attention to the fact that recent annual hikes have been disappointing at between 1% and 2%.
There’s also the valuation to consider. Trading at 15 times expected earnings, United Utilities still looks too expensive at the current time.
Special dividend
Given the choice, I’d far rather opt for £13bn cap plumbing and heating products and building materials distributor Ferguson (LSE: FERG), especially after today’s encouraging set of interim results.
At just over $10bn, ongoing revenue was 10.3% above that achieved over the same period in the 2016/17 financial year. Ongoing trading profit also rose a healthy 15% to $698m.
According to CEO John Martin, Ferguson (formerly known as Wolseley) delivered a “strong performance” over H1 thanks to “good growth and margin progression” in the US. Indeed, organic revenue from operations over the pond rose 8.7% in the reporting period. Improved growth was also seen in the Canadian market.
Despite stating that UK markets were “challenging” and that the company faces “progressively tougher” comparators in H2, Ferguson’s top man went on to reflect that the company was “confident” of achieving analyst expectations for full-year profits.
Perhaps most positively for income investors, the Switzerland-based firm proposed a special dividend and share consolidation of around $1bn after confirming that it expects to complete the sale of building materials firm Stark Group at the end of the month. This was in addition to an encouraging 10% hike to the interim payout.
These facts, combined with improving returns on the capital it invests, falling debt and far greater geographical diversification, make Ferguson the clear winner for me.
