The Pros And Cons Of Investing In United Utilities Group plc

Stock market selections are never black-and-white decisions, and investors often have to plough through a mountain of conflicting arguments before coming to a sound conclusion.

Today I am looking at water giant United Utilities Group (LSE: UU) (NASDAQOTH: UUGRY.US) and assessing whether the positives surrounding the firm’s investment case outweigh the negatives.

Heavy capex costs keep rolling

As one would expect, United Utilities has to continually plough vast amounts of capital into upgrading its colossal network of pipes and stations to keep its core commodity flowing. Fuelled in part by a need to meet environmental obligations, it’s a significant drag on profitability.

The company announced in October’s interims that regulatory capital expenditure advanced to £407m during March-September, up from £354m during the corresponding 2012 period. In all, United Utilities expects to fork out at least £800m in the current year alone.

Earnings to edge steadily higher

Still, the fruits of this heavy investment over many years is expected to keep revenues — and consequently earnings growth — increasing, at least into the medium term.

City analysts have pencilled in earnings per share growth of 13% in the 12 months ending March 2014, to 44.2p per share, before edging an additional 2% higher the following year, to 45.1p. These figures create P/E ratings of 14.9 and 14.6 respectively, below the gas, water and multiutilities sector’s prospective average of 18.3.

Regulators upping the stakes

However, recent overtures by water regulator OFWAT — echoing the recent furore over escalating electricity bills on household budgets — has shown that it is becoming increasingly vigilant in its stand against sector constituents’ plans to implement price hikes, a backdrop that could severely dent their profitability in future years.

Following water companies’ price proposals for the 2015-2020 period, the regulator announced in December that

initial testing of companies’ views on risk and reward has shown that they are not in alignment with market evidence for the water sector,”

and that it would be

providing companies with a further opportunity to secure the best possible outcome for customers.”

A decent dividend outlook

Although United Utilities’ earnings outlook — at least in the near-term — could probably be best described as solid if unspectacular, the same cannot be said of the firm’s dividend profile.

The water provider is expected to shell out payments of 36p and 37.8p in 2014 and 2015 respectively, dividends which would result in yields of 5.3% and 5.6%. These readings outstrip the forward mean of 4.6% for its sector peers as well as the FTSE 100 equivalent of 3.2%.

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> Royston does not own shares in United Utilities Group.