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Why United Utilities Group PLC Should Be A Winner This Year

The utilities sector has been a favourite with income investors for years, as it pays nice steady dividends. But recent political noises about energy prices have taken their toll, and share prices have fallen. Today I’m turning my attention to United Utilities (LSE: UU) (NASDAQOTH: UUGRY.US) to see what I think about its prospects for 2014.

First, here’s the company’s past five years of headline figures, with consensus forecasts for the next three:

Mar Pre-tax EPS Change Dividend Change Yield Cover
2009 £529.3m 26.5p -57% 32.67p   6.8% 0.8x
2010 £408.7m 50.8p +92% 34.30p +4.6% 6.1% 1.5x
2011 £327.1m 35.1p -31% 30.00p -13% 5.1% 1.2x
2012 £280.4m 35.3p +1% 32.01p +6.7% 5.3% 1.1x
2013 £304.7m 39.1p +11% 34.31p +7.2% 4.8% 1.1x
2014* £384.5m 44.1p +13% 36.01p +4.9% 5.5% 1.2x
2015* £390.1m 45.3p +2% 37.78p +4.9% 5.7% 1.2x
2016* £358.1m 41.7p -8% 35.86p -5.0% 5.4% 1.2x

* forecast

Share price dance

The United Utilities’ share price has behaved a little curiously over the past few years, and it’s worth a look.

Over the past three years, the shares are ahead of the FTSE 100, having gained approximately 18% compared to the index’s 13%. But that does include a fall over the past 12 months, with United Utilities down around 3% compared to an 11% rise for the FTSE.

The recent fall is quite easily explained by electioneering threats to curtail the industry’s profits, although political parties who think they can control energy prices in the longer term are surely deluded — and even Labour’s price-capping threats are really not that drastic.

Demand for income

The earlier price rise was at least partly due to the low-interest rate environment we’ve been in during the recession, and the need for reliable income from a large section of the investment world. When there’s little to be had from interest-bearing investments, dividends are there to fill the void — and those from the utilities are amongst the most reliable in the market.

United Utilities is in the enviable position of having a captive customer base. It is able to predict its income more accurately than many other businesses, and costs are reasonably predictable due to the buying of long-term fuel contracts. The utilities companies, including United Utilities, are able to pay out a large proportion of their earnings as dividends.

Correction

Now, the demand for those dividends did push the share price valuation up a little, with a year-end price-to-earnings (P/E) ratio of 17 at March 2012, rising further to 18 a year later. That was perhaps justified by dividend yields of around 5%, but it was maybe a bit stretched.

And now that the share price has fallen back, that P/E has dropped and is looking attractive. Analysts suggest an average of around 15 based on forecasts for the next three years, which is only slightly higher than the FTSE’s long-term average of about 14. But those dividends are a good bit higher than the market average, which is only slightly above 3%.

Looking good

That combination — of strong and reliable dividends, and a share price depressed in the short term — is what makes me think United Utilities is in for a good 2014. I really can see the combination of share price and dividends giving shareholders a FTSE-beating year.

Verdict: Powering up in 2014!

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> Alan doesn't own any shares in United Utilities.