The United Utilities (LSE: UU.) share price is recovering this afternoon after losing 3% this morning following a mixed earnings report. It has regained 2% to reach £11.03 after falling to £10.79. Over the past 30 days, however, it’s still up by 10%.
Despite the early dip, the 2023 full-year earnings report revealed some decent progress and growth on certain metrics. Revenue is up 8.3% to £1.95bn compared to £1.8bn last year, leading to a dividend increase of 9.4%.
On the announcement, CEO Louise Beardmore said the company has met or exceeded around 80% of its regulatory targets. “Our finances are robust with one of the lowest levels of gearing in the sector“, she said.
So what’s that smell?
For those living in the Windermere area of the Lake District, some may be asking why the early summer air smells a bit miffy. That’s the lingering stench of sewage that spilt into the lake following a fault at the Bownes-on-Windermere pumping station in February.
The spill was allegedly caused by an unexpected fault in a telecoms network that affected a backup system.
In this morning’s results, United Utilities announced £400m worth of investment to avoid future spills. However, it may still face legal action from the Environment Agency. The spill and subsequent investment were partly responsible for a 51% fall in pre-tax profit, down from £256m to £170m this year.
Strong dividend payer
Despite the controversy, United has been delivering acceptable returns for shareholders. In the past year, it has returned 4.6%. That’s a fair bit higher than the overall UK Water Utilities market which fell 3.9%. In the past five years, the share price is up 41% with consistent dividends steadily increasing for 10 years.
Independent analysts forecast the company’s earnings to grow at a rate of 38% going forward, predicting a future return on equity (ROE) of 19.8%. By comparison, fellow water works company Severn Trent‘s earnings are only expected to grow at a rate of 24.6%. It’s also had a far worse year than United, with the share price down 10% since last May.
Overall, the UK water utilities industry appears to be struggling at the moment but United may be doing better than others. However, is it enough to save its strained balance sheet?
The debt monster
United Utilities has £9.1bn in debt shored up by only £2.17bn in equity and short-term cash of £828m. That leaves it with a very high debt-to-equity ratio of 417% and only 1.8 times interest coverage. I would say this makes it a risky investment, as there appears to be a high possibility of financial troubles if things don’t improve soon.
The situation also increases the likelihood of dividends being cut, reducing one of the stock’s key value propositions.
There does seem to be some improvements occurring at United but any further environmental accidents could spell catastrophe for the company. It doesn’t appear to have the capital to keep patching up incidents with the promise of investment, so it’ll need to operate more carefully. While the dividend is attractive, I believe the risks posed by the company’s debt situation overshadow it.
