Water is one of the few industries where a glut of the principal raw material can be disastrous. We all want a dependable water supply, but we also want our water companies to cope with floods and, as The Times Clean It Up campaign demands, civilised sewage disposal. As well as making the industry uniquely dependent on the weather, the environmental demands are increasingly difficult to reconcile with pleasing shareholders.
So when Severn Trent and United Utilities published their latest trading updates, the financial outlook was almost an afterthought. United began by saying it had “continued to deliver strong operating performance, resulting in no material changes to 2023-24 financial guidance”, before getting on to how it was supporting customers and improving service. Severn prioritised its environmental performance, before adding that “there have been no material changes to the current year business performance or outlook since the interim results announcement”.
All of which demonstrates that investors in this sector have to recognise their position way down the pecking order. That was always part of the deal with previously state-owned monopolies, but compared with rail, gas, electricity and post there is a constant threat of water disaster that was barely considered when the sector was privatised 35 years ago.
Joseph Chamberlain, the Victorian politician, spotted the conflict in 1884: “It is difficult, if not impossible, to combine the citizens’ rights and interests and the private enterprise’s interests, because the private enterprise aims at its natural and justified objective, the biggest possible profit.” That led to the widespread nationalisation of water supply, barring a few local firms that did not fit conveniently into the overall pattern.
As with other privatised industries, the government-appointed regulator assumes extra importance, especially since the water regulators have the power to impose penalties and rewards. United bemoaned last year’s exceptionally high rainfall in its northwest England territory, a third higher than the long-term average with 14 storms strong enough to be named. That has cost the company £25 million in lost outcome delivery incentive, or ODI, payments, taking its expected award down to about £40 million for the year to the end of next month.
Advertisement
The Coventry-based Severn emphasised its efforts to retain its four-star status in the Environment Agency’s annual Environmental Performance Assessment for a fifth consecutive year, the best in the industry, despite complaints from Welsh and Birmingham-based customers. Four-star status requires zero serious pollution incidents, however defined, and the group expects to earn £50 million this financial year in ODI rewards. Hence there are no threats to dock any of the £3.2 million annual pay package of Liv Garfield, chief executive.
That does not come cheap, though, and Severn said it had invested £3 billion over the past four years to improve customer service and to “add further resilience to our network”. With net profits last year of only £132 million, the company has to keep its financial channels as pollution-free as its drains, underlined by a £1 billion share sale to institutions and the Qatar Investment Authority last year.
As water is hardly a growth area, the industry has always had a strong emphasis on dividends. Indeed, Severn and United were criticised after their half-year results last November for distributing more to shareholders than they had made in net profit. While Severn pointed to the need to strike a balance across all stakeholders, United said it was committed to raising dividends by the rate of inflation, “a stable and predictable approach that appeals to long-term investors like pension funds, who, in turn, support our ambitious plans to invest billions of pounds”. The pressure to do so was particularly acute last year when Britain’s annual inflation rate touched 11 per cent, the highest so far this century, and that could be a continuing challenge for a while yet.
Jefferies, the investment bank, recently upgraded its recommendations on Severn and United, saying that their “unprecedented opportunity for multi-year growth, alongside a potential for reasonable investment returns, outweighs our previous concerns about political/regulatory risk”. There is little to choose between them, but the weather outlook gives Severn the edge because it tends to have fewer floods than United.
Advice Hold United, buy Severn
Advertisement
Why Severn has a more predictable income stream
Renishaw
It is unusual enough for a company’s shares to jump after a profits fall to question what is going on. Last week, shares in Renishaw rose by 16 per cent after the precision engineer said its adjusted pre-tax interim profits had fallen from £73.5 million to £56.5 million on revenue £17.2 million lower at £330.5 million. That took adjusted earnings per share down from 83.4p to 62.1p, although the interim dividend was held at 16.8p.
Despite a profit warning last year, investors were willing to ignore such negativity in favour of the promise from William Lee, the chief executive, that “we expect an improvement in our trading performance in the second half of the financial year as market conditions improve and as we continue to pursue a range of growth opportunities”. The shares went from £34.36 to £41.70 in a week before taking a breather.
Renishaw shareholders should be used to regular stumbles. There have been three declines in annual revenue and pre-tax profit in the past ten years, suggesting an inherent volatility in the product mix; this time the company blamed “weak demand” for semiconductor equipment encoders. It makes measuring instruments, metal 3D printing machines, micro-instruments for facial reconstructions and neurosurgery and micro-components for Chinese smartphones, all loosely co-existing under the “precision engineering” umbrella.
The 51-year-old company has the advantage and disadvantage of still being run by its founders, Sir David McMurtry and Daniel Deer, now in their eighties, who clearly still enjoy inventing but may not be sufficiently open to the strategic rethink a business often needs at this stage. Together they own a 52 per cent stake, which they tried to sell three years ago, only to fail to find a buyer to their taste or purse. The eventual withdrawal could be complicated.
Advertisement
The shares trade at 25 times earnings and yield under 2 per cent. UBS rates Renishaw a “buy”, arguing that the shares offer a high risk/reward ratio, but maybe significant upside. However, their counterparts at Stifel think the stock market may be underestimating the risks.
Advice Hold
Why Too many unknowns
