With relatively static revenues, water companies are unlikely to deliver the long-term gains to shareholders that others in less regulated industries can. But as a dividend hunter looking for steady and reliable passive income, should I include the two FTSE 100 water industry giants in my portfolio?
Opening the taps
Since 2019, Severn Trent (LSE:SVT) has increased its dividend by an average annual growth rate of 3.4%. Assuming this is repeated in the current financial year, the stock is presently yielding 4.4%.
United Utilities (LSE:UU.) has grown its shareholder payout by 2.5% annually over the same period. If this continues, it will return 4.9% this year.
Both are offering yields in excess of the FTSE 100 average.
And each has a long history of increasing dividends year on year. Severn Trent last cut its payout in 2016. United Utilities did it in 2010.
| Financial year (31 March) | Severn Trent dividend per share (pence) | United Utilities dividend per share (pence) |
| 2019 | 93.37 | 41.28 |
| 2020 | 100.08 | 42.60 |
| 2021 | 101.58 | 43.24 |
| 2022 | 102.14 | 43.50 |
| 2023 | 106.82 | 45.51 |
Slow and steady
On this basis, I think both meet the definition of steady and reliable dividend shares — the type of stock that could be tucked away in my portfolio and forgotten about.
Capital growth is unlikely to be spectacular because their earnings — a bit like their dividends — are predictable.
But there shouldn’t be any significant downside either. When Russia invaded Ukraine and the world’s stock markets became jittery, these two stocks remained largely unaffected.
However, despite this, I don’t want to invest in either at the moment.
Let me explain.
Bad press
Water companies have featured prominently in news headlines recently.
There’s increasing dissatisfaction with the pumping of raw sewage into our rivers and seas, whenever there’s heavy rainfall.
And the policy of privatisation has been scrutinised as the industry is accused of rewarding shareholders at the expense of customers.
For these reasons, I’d be nervous about buying shares in either of the FTSE 100’s two water companies.
With an election looming, it’s likely that the government will put pressure on the regulator to force these companies to invest more in infrastructure.
If I’m right, this can only be paid for by squeezing dividends. Increasing customer bills would be politically unacceptable.
Drowning in debt
But my main reason for not wanting to invest is the level of borrowings that both companies are carrying. Their net debt is currently around 10 times their cash flow from operations (CFFO). And more than their current stock market valuations.
| Measure | Severn Trent | United Utilities |
| Net debt at 31 March 2023 (£m) | 7,161 | 8,201 |
| CFFO 2023 (£m) | 713 | 883 |
| Net debt : CFFO | 10.0 | 9.29 |
To put this in context, if BP had the same ratio, it would have net debt of over $400bn at the end of 2022, compared to an actual figure of $21bn.
And to make matters worse, the rate of interest paid on some of the borrowings of Severn Trent and United Utilities isn’t fixed.
In fact, some of it’s linked to the retail prices index, which is currently over 11%.
| Type of debt at 31 March 2023 | Severn Trent (%) | United Utilities (%) |
| Fixed rate | 67 | 43 |
| Floating rate | 5 | 10 |
| Index linked | 28 | 47 |
| Total | 100 | 100 |
Both companies are therefore experiencing significant increases in their interest costs. As they are unable to pass these on to the customer, it could mean there’s less cash available to return to shareholders.
The healthy yields presently on offer may soon be a thing of the past.
For much of the past decade, inflation has been comfortably below 3%. Now that it’s well above this level — and interest rates are likely to increase further — I’m going to look elsewhere for passive income opportunities.
