City fears grow over United Utilities

Jun 18 2008 by Alex Turner, Liverpool Daily Post

UNITED Utilities’ stock is overpriced because the water group is likely to suffer from rising costs and an unsatisfactory price review by water industry regulator Ofwat, according to City analysts.

The Warrington-based company is preparing to return £1.5bn to shareholders in August after it sold its electricity arm, Norweb, last year and analysts at Merrill Lynch believe that investors have still not factored in the dilution from this capital return.

A report by lead analyst Robert Miller-Bakewell of Merrill Lynch expressed concerns about United Utilities’ performance in the next couple of years.

The report anticipates a rebound in power costs that may cost the company an extra £20m-£25m in 2008-09 and a rise in bad debts, which it estimates may return to near the peak levels of 2002-03 of 4.9% within the next two years.

It said: “It is unclear whether or not the group’s comments about power costs and bad debts constituted a profits warning. However, mechanistic interpretation suggests that United Utilities Water could well be facing a flat year.”

It is forecasting second-half profits could fall by 15% or more in the six months from September 2008 on the back of an uplift in finance costs of an estimated £40m. The Merrill report also expressed concerns that the utility firm is unlikely to get the water charge increases it is requesting at next year’s price review.

“In our view, neither Ofwat nor the environmental regulators are likely to cut United Utilities Water any slack at the price review,” the report said.

“To date, the share price is ignoring regulatory risk, perhaps because of the lure of the 170p/share cash return.

“As the price review process unfolds, we expect that United Utilities’ shares will be seen as less attractive than those of its quoted peers as greater weight is given to the impact of the price review,” the analysts said.

However Carl Cross, a Liverpool-based investment director at Rensburg Sheppards, was more positive about the company’s share price.

“The company is in great shape,” he said. “The underlying operational performance is very good, and it’s got good structures in place.

“It has very, very secure revenues and earnings, everyone knows what it does and that will make it attractive.”