Is the 5% dividend yield from the FTSE 100’s United Utilities Group worth having?

There’s no doubt that United Utilities Group plc (LON: UU) pays a big dividend, but I think there are risks.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

It used to be easy to invest in the utility sector. Most investors assumed that names such as water company United Utilities Group (LSE: UU) operated steady, cash-generating businesses supported by their monopoly positions in the market. So, it seemed like a no-brainer to buy the shares to collect the often-large dividend payments with the reasonable assumption that the underlying business would be stable for years to come.

It always seemed as if the share prices of the utility firms would be unlikely to cause too much trouble during a long-term holding period — therefore, we thought, we’d invested in a low-risk compounding machine, and all we had to do was periodically reinvest the dividends and wait for a happy and prosperous retirement.

Big questions

But I don’t think it is as simple as that now. A number of big questions hang over the utility sector that challenge our previous cosy assumptions. Firstly, there’s the large pile of debt that many utility companies carry. Capital-intensive operations in the sector require huge amounts of money to develop and maintain, and utility companies have turned seeking, managing and servicing borrowings into an art form. United Utilities, for example, revealed in today’s half-year results report that its gross borrowings stand around £8.68bn, which compares to last year’s underlying operating profit of £645m – the figure for debt is large, and the sheer quantity of words dedicated to talking about borrowings in today’s report underlines how big an issue it is for the firm.

Of course, there’s nothing new about utility companies running up large piles of debt, but the regulators have been cranking up the pressure on firms such as United Utilities. It wouldn’t take much to tip the balance so that the big figures of revenue and costs fail to produce enough of the little figures for free cash flow and profit. If that happens, the directors could face hard choices between servicing the interest on borrowings or servicing shareholders with a dividend. Perhaps they could end up with a situation where they can’t service both. If that happens, expect dividends to be cut and share prices to fall.

Yet debt and regulatory risks aren’t the only things to worry about. I reckon there’s also a lot of political risk hanging over the utility firms at the moment. Labour and the Conservatives seem close in the polls and the next general election could see a Labour government – one that has pledged to nationalise utility companies. If that happens, I certainly wouldn’t want to be holding shares in any firm that falls in the crosshairs of politicians in power who want to ‘get even’ with ‘greedy’ capitalist directors and shareholders!

Good figures

Despite my reservations, today’s figures are good. Revenue for the first half of the firm’s trading year rose 4.6% year-on-year and underlying earnings per share shot up almost 23%. The directors pushed up the interim dividend by 3.9%. At the recent share price of 775p, the forward dividend yield for the trading year to March 2020 runs around 5.5% with the payment covered almost one-and-a-half times by anticipated earnings. If you are comfortable with the over-arching risks and uncertainties, the yield looks attractive. But, to me, it’s a big ‘if’.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Happy young female stock-picker in a cafe
Investing Articles

Operating profit up 26%! Auto Trader is leading the FTSE 100 on results day

An explosive move higher from the Auto Trader share price suggests the full-year results are good, but is the stock…

Read more »

Midnight is celebrated along the River Thames in London with a spectacular and colourful firework display.
Investing Articles

If I’d put £2,000 in Nvidia stock when ChatGPT came out, here’s what I’d have now

Our writer looks at the eye-popping gains that Nvidia stock has made in the 18 months since the release of…

Read more »

British Pennies on a Pound Note
Investing Articles

This former penny share is up 163% in a year. Could it be worth even more?

Christopher Ruane explains some of the concerns that kept him away from a penny share before its stellar rise --…

Read more »

Young Caucasian woman with pink her studying from her laptop screen
Investing Articles

I’m not convinced the Dr Martens share price is a bargain. Here’s why

After the bootmaker reported its full year results today, our writer explains why a Dr Martens share price in pennies…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

Should I invest in the S&P 500 or FTSE 100?

Ben McPoland thinks one FTSE 100 stock might offer a compromise between high US market growth and cheap Footsie valuations.

Read more »

Young Caucasian woman with pink her studying from her laptop screen
Investing Articles

How much passive income could I earn by investing £100 a month in UK shares?

With just a £100 monthly investment in UK dividend shares, I could achieve a decent passive income stream of over…

Read more »

Young Woman Drives Car With Dog in Back Seat
Investing Articles

Looking for cheap growth shares? Here’s a FTSE 250 stock to consider in June

Pets at Home shares still look dirt cheap, says Royston Wild. Here, he explains why the retailer might be one…

Read more »

Number three written on white chat bubble on blue background
Investing Articles

The 3 big risks to Lloyds’ share price in 2024!

Is the Lloyds share price one of the FTSE 100's worst investor traps? Royston Wild thinks the bank's shares could…

Read more »