HYP4: Share No. 4, Bowing To The Inevitable

By Stephen Bland | 6 December 2006

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It's that time again, first article of the month, when I add a new share to my fourth High Yield Portfolio (HYP). Of the three shares chosen already, two were selected by a slightly different process to my standard routine for HYP share selections. The latter consists simply of working my way down the FTSE 100 ranked by descending yield, with the occasional FTSE 250 share thrown in, picking the next share from each sector that satisfies my filter criteria.

However, with HYP4 I decided to step out of line in some cases and pick shares that I thought were temporarily undervalued on yield due to poor sentiment, even though they were not next on the descending yield list.

With share number four, I'm back to the normal method with regular HYP favourite United Utilities. This share has figured in, I think, every HYP I've set up on the Motley Fool since I launched the strategy back in 2000. The reason is simply that it has remained one of the highest yielders amongst big caps for all that time and represents a new sector for HYP4 of water/electric utilities. Sector diversification, remember, is critical as a risk amelioration factor in the HYP strategy.

Despite its regular appearance in HYPs since Adam took one look at Eve and decided he wanted to put his share in her portfolio, there are actually a few things that are wrong with UU as an HYP play.

First of all it has a net debt level that is so high such that if it were a noise, only dogs would hear it. I make it around 164% of shareholders funds at 30/09/06. Secondly, dividend cover is decidedly low and thirdly, its dividend history does not demonstrate overwhelming growth. In fact, the dividend history appears to show small cuts in recent years but that is due to the distortions of the complex two stage rights issue over that time according to the company.

I can't be bothered to work out all the implications of the rights issue on dividends myself, having taken someone's advice long ago to get a life. Having gotten a life, I am prepared to take the company's word that their stated policy is to grow dividends in line with inflation. This is confirmed with the announcement of results just published for the half year to 30/09/06, showing an inflationary rise in the interim dividend. Incidentally they go ex-dividend on 20 December for anyone wanting to catch the next payment.

So why go for UU if it presents the above apparent weaknesses? Because I don't regard my HYP selection criteria as inviolable and am prepared to overlook some of them in cases where there is adequate compensation in terms of a much higher yield.

At my buying price, including costs, of 779p and last year's dividend of 43.87p the yield is 5.63%. Looking forward, with a dividend forecast for the 31/03/07 year of 44.95p, the yield is 5.77%, second highest in the FTSE 100 of those companies with a dividend history. And that is the trade off for the weaknesses.

Note that for whatever reason UU's price has been relatively strong against the FTSE100 over the last few months, which might put off some people who consider that it is consequently due for a fall. I say ignore this because I don't think price movements should be taken into account for HYP shares. My HYP strategy is driven only by fundamentals. This means that either the share on its fundies is an attractive choice or it's not. Recent share price action is irrelevant.

Here then is the HYP4 table so far, cost includes all purchase expenses:

Stephen owns shares in all of the above companies