Water companies such as United Utilities (LSE: UU) and Severn Trent (LSE: SVT) have traditionally been great investments for investors seeking a defensive long-term income stream.
Indeed, the world will always need water and infrastructure to get it where it needs to be, so these companies should, in theory, be able to provide you with a steady income for the rest of your life.
But as my Foolish colleague Peter Stephens recently pointed out, over the past year, political and regulatory risks have scared investors away from these companies, the result being that shares in United Utilities and Severn Trent have significantly underperformed the broader market.
Time for a turnaround?
Shares in United have lagged the FTSE 100 by around 27% excluding dividends over the past 12 months, while shares in Severn have underperformed by approximately 22% over the same period.
However, these declines have left the shares offering what is known in value investing circles as a ‘margin of safety’. Put simply, this means that selling of these shares now appears to be overdone and all the bad news is now reflected in the share price, but there’s no allowance given for a possible positive surprise.
That being said, it is difficult to argue that the operating environment for water companies will become more comfortable over the next few years. It’s more than likely that most of these firm will have to reduce the amount of cash they return to shareholders as regulations bite. Nevertheless, I do not believe that United and Severn will be forced to cut their dividends altogether, which leads me to conclude that they will both continue to provide you with a steady income stream for many years.
A margin of safety
At the time of writing, shares in United support a dividend yield of 5.8%, compared to the market median of 3.2%. If we assume the worst and factor in a dividend cut from 40p (City forecast for 2019) to 20p, investors will be left with a yield of 2.9% at current prices. That’s below the market median but still an attractive level of income from a defensive asset. Meanwhile, a 50% dividend cut at Severn would leave the company with a dividend yield of 2.6% (also based on 2019 City figures).
These figures show that even if the two companies are forced to cut their dividends, they will remain attractive income investments. What’s more, even in this adverse scenario, it is likely that the payouts will continue to grow at a rate greater than or equal to inflation.
So overall, while United and Severn might not be the most popular stocks around at the moment, they should continue to be reliable income plays for you to buy and hold in your portfolio. Even in the most adverse scenario, the two companies will continue to offer defensive, inflation-protected dividends, top qualities that few other stocks offer.
