Why this FTSE 100 stock is my contrarian pick

This FTSE 100 stock just reported weak results and its share price increase has been underwhelming too. So why does Manika Premsingh like it?

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As large companies with mostly stable demand, FTSE 100 utilities are unlikely to qualify as contrarian stocks. But when I looked at water and wastewater services provider United Utilities (LSE: UU), it looked very much like a contrarian investment. 

Here is why. 

Underwhelming share price, weak results

United Utilities’ share price increase over the past year is an underwhelming 13.7%. Considering that the stock markets were just coming out of a once-a-decade crash, most stocks’ prices were particularly low. And in line with that, their gains by now look significant. Not for United Utilities, however. 

Additionally, its share price today, too, is slightly down after its results. For the year ending 31 March 2021, its revenue is down almost 2.8% and reported operating profit is down by 4.4%. Underlying operating profit is even more affected, down by 21%. 

This is perplexing at best and disappointing at worst. To me it looked strange that a utility saw such a decline, even considering the lockdown and subsequent reduction in business demand. 

There is an explanation

The answer is there in the fine print. The United Utilities revenue declined not because of a fall in demand, but because of the start of a new pricing cycle. Every five years, the water regulator Ofwat sets new prices for consumers. 

Because of the implementation of the new cycle from 2020 onwards, customer bills have reduced by 5.5%. This is reflected in the revenues. The fall in earnings is also explained by this as well as by increased capital spending, which is not a bad thing at all, in my view. 

In the past years, United Utilities has consistently shown increased revenue, so I am not concerned because of a blip in one year. Its profits have been less consistent, but it has consistently been profitable. 

It is probably this performance that explains why the stock market crash did not impact its share price for long either. While it did drop sharply in the stock market meltdown, it was already back to pre-crash levels as early as June last year. After some fluctuations for the rest of the year, it was recently back above 1,000p. These levels were last seen in February last year.   

More reasons to like the FTSE 100 stock

I also like that its valuation is reasonable. According to my estimates, its price-to-earnings ratio is around 18 times, lower than that of many other FTSE 100 shares. 

There is more. It has a dividend yield of 4.2%, which is pretty decent according to me. It is also a good reason to buy a stock with a competitive earnings ratio, which has the potential to rise more. 

There are other FTSE 100 utilities with higher dividend yields around as well, but I would consider this seeming contrarian pick too. 

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 considered so you should consider taking independent financial advice.

Manika Premsingh 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.

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