United Utilities good value at 600p 4 August 2010

 

The water company United Utilities (UU.) is not wholly immune to macro economics. However, it supplies a product for which there is a strong core need both today and in the long term. It is a company which is almost wholly reliant on the judgements of OFWAT the industry regulator, which last year produced its review laying down the next few year’s water prices and investment expectations. Although it put pressure on the water companies it has allowed their planners to do so on facts rather than assumptions.

 

United Utilities has responded by cutting back dividend payout by £124 million from £350 million rebasing it at a last year’s £226 million. Whereas the dividend was 34.3p last year it is now estimated at 30.6p for this year, rising to 31.5p next year to March 2012. That puts the shares on forward, sounder forward dividend yield estimate of 5.1% for this year rising to 5.25% for next year. Those payouts are now estimated to be covered by earnings forecast at 30.6p for this year and 31.5p next year. The earning cover is 1.3 times; reliable enough for a company living in a more predictable market than most others. It is my reading of the situation that the regulator had come to the conclusion that shareholders were getting too big a payout in relation to customers. Now that has been done water companies at least know where they stand over the next few years. Such confidence and visibility is generally in short supply at the moment.

 

The company is also a powerful generator of cash from operations. Last year it produced operating cash of £800 million, valuing the equity at 5 times operating cash. Cash in the balance sheet of £302 million represented a cash yield of 7.5%.    

 

Apart from a dividend payout that looks handsome in relation to what you get from your local friendly high street bank, United Utilities equity is backed by a massive attributable asset position and in turn commands an even larger total asset enterprise value should a bidder appear. Very simply, balance sheet assets attributable to shareholders last year were worth an estimated 219p a share or 37% of the share price. On that basis, if the remaining 336p of the share price is the value paid for earnings, the price to earnings multiple estimated for this year and next falls to 11.9 times on that calculation (down from 14.9 times on the full quoted share price of 600p) and 11.6 times next year’s estimate earnings per share of 31.5p. Moreover the equity commanded total assets of £9.6 billion. That translates into an enterprise value of approximately £14 a share. With a good forward dividend income based on a recently reconfigured cash payout to shareholders and well backed by attributable assets and the massive enterprise value of the business the shares are a BUY

 

King Solomon’s Mind.

 

Investing over the last couple of years – all kinds, not just equity investing – has had all the complexity of unprecedented events (like the lowest interest rates since before the establishment of the Bank of England) combined with historical comparisons from the Great Depression eighty years ago sown on to the implications of the long awaited awakening of the Chinese economy from the long sleep it went into in the eighteenth century. To that add the economic and investment implications of the imploding experimental Euro and you have a small measure of the daunting challenge to forecasters. It has in part been a matter of getting down those old economic text books and economic histories from the book shelf, blowing off the accumulated dust in an attempt to help illuminate and understand the mystery of the last few years. Whoever it was who a decade ago prematurely pronounced ‘history is dead’ could not have got it more wrong.

In the UK the debate about the likely economic impact of shoving on the brakes to government spending when the economy is still weak continues. That jury is out. We need to look at each bit of macro economic evidence of recovery as it appears; a demanding task these days even for King Solomon who has the patent rights on wisdom in perpetuity. It’s my instinct that I will probably not have to pursue George Osborn for infringement of them.

The world economy is like the curate’s egg, is good in parts. We have low and falling unemployment and sky high consumer and business confidence in Germany; something similar but less pronounced in La Belle France, bread and water austerity (only starting) in the largely Latin and Greek orthodox quarter of the Eurozone as well the emerald pasture of the late, now very dead, Celtic tiger. The stress testing of European banks seems to have been largely accepted as being less than ideal but more than just realistic. In the UK we have a reworking of radical, nihilist government policy and the political philosophy of chucking things in the air and watch where they fall. In the US we continue to have a faltering economic recovery. Each quarter’s GDP growth comes in lower than the last.

 The BRIC economies (Brazil, Russia, India and China) continue to grow significantly although the balance sheets of China’s Banks appear constrained by bad and doubtful loans in the last year or so. Gold has fallen but oil and copper have risen.

The Euro is recovering against the US dollar, which has suddenly lost its shine as its haven against European Sovereign debt problems. We may be heading towards a second chapter of dollar worries, in which case gold will probably retrieve its own safe haven qualities.

As pointed out by this publication for some time, large companies have cut back their operating cost bases, generated cash and put their balance sheets in order. Hence the generally good results season on Wall Street.