MARKET COMMENT
Shares To Revive A Parched Portfolio

By David Kuo (TMFDragon)
September 1, 2003

Why do people invest in water companies?

The typical answer is for the attractive dividends that these companies pay out. United Utilities (LSE: UU.)(NYSE: UU), for example, is on mouth-watering prospective yield of 8.8% and Severn Trent (LSE: SVT) is on a salivating 7.3%.

However, just recently, the future dividend payouts at these companies have been thrown into turmoil. This is because of the wranglings that are going on between the water companies, the water regulator and various consumer groups.

The water companies, as represented by Water UK, want to increase their investment in the crumbling water pipes and sewers around the country. These need to be replaced fairly soon to avoid what they describe as a possible Railtrack-type disaster. The amount of investment is estimated to be as much as £21b over a five-year period starting in 2005, significantly higher than the £17b which is reckoned will be invested in the current five-year review period.

Ofwat agrees that substantial investments will be needed. But whilst the water regulator agrees that more capital expenditure is needed, it bizarrely ordered price cuts in our water bills some three years ago. This reduced the profits at many of the water companies that could have been used for future repairs and renewals.

Meanwhile, the consumer groups are not happy with the proposals by the water companies to raise the level of water bills. WaterVoice, a consumer pressure group, reckons that any increase in investment should be borne by the shareholders of the privatised water companies.

So there we have it. Everyone agrees that the ageing pipes need replacing but no one wants to fork out for the repairs. What a mess!

However, Ofwat has already hinted that customers could face increases in their water bills from 2005. Just how much our water bills will rise will not be revealed until November next year.

That would suggest that dividend payouts from the water companies are unlikely to be cut too severely, if at all. For those investors who are drawn to higher yielding shares, the water companies certainly look refreshing at these prices.

Apart from United Utilities and Severn Trent, other generous dividend payers include Pennon Group (LSE: PNN), which is yielding 7.1%, and Kelda Group (LSE: KEL) on 6.5%.

The only reservation that I have would be the high level of debt that many of these companies currently carry. United Utilities had net debts of £3.3b or 130% of total shareholders' funds while Severn Trent's gearing is nearly as high at 113%.