UK utility companies have for some time been regarded as a relatively stable investment opportunity, given the reliable, long-term nature of their income streams. Recently, utilities have been going through tougher times, with pressure from the government to reduce prices, and a less favourable outlook for the future. But does this mean that investment in the sector should be avoided?
Water
There are over 20 water companies operating in the UK, each of which is regionally based and regulated in terms of water supply in its region. The larger companies include United Utilities, serving the North West of England, Thames Water, serving the London area, Pennon (owners of Southwest Water), Northumbrian Water Group Plc, and Severn Trent .
During the recent recession, the revenue streams earned by water companies have suffered as both industrial and domestic demand has decreased, due to the number of failing businesses and the impact of the growing number of domestic customers having water meters installed. As a result, the water companies submitted proposals to Ofwat in autumn 2007 to increase water prices in order to fund a collective £21bn investment in infrastructure.
The proposals have been rejected by the regulator, and instead, the majority of companies are under pressure to reduce customer bills to 2015, with the exception of Northumbrian and Essex and Suffolk, both owned by Northumbrian Water. Ofwat is proposing that the level of return that water companies are permitted to make on their regulated asset base (i.e. cost of capital) is set at 4.5%, whereas research commissioned by the industry suggests that a level of 4.6 – 5.1% is required to fund necessary investment. [1] Although the water companies will have the chance to lobby before Ofwat’s final price control announcement on 26 November, the news has had a negative impact on some providers’ share prices.
Pennon, who had modelled a cost of capital of 4.78%, saw its share price fall by 3%. United Utilities’ share price saw the biggest fall at 5.5%, although in a trading statement issued, the company announced that it would increase dividends by 5% this year. [2] Severn Trent ’s share price also fell by 7.6% following Ofwat’s news.
With customers in some areas of the country living in ‘water poverty’, i.e. spending 3% or more of their income on water bills, Ofwat will be under…
