Water giant backed to keep dividend afloat

United Utilities Group Class A (LSE:UU.) shares were boosted today when a City bank said the North West supplier’s Ofwat draft determination “is very close” to a level that supports the dividend.

UBS lifted its recommendation to Buy, with its new price target of 1,150p a 16% upside on this morning’s 990p after United shares neared the top of the FTSE 100 index.

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The bank is also supportive of FTSE 250-listed Pennon Group (LSE:PNN), even though its base case is for a 25% cut in the dividend. Severn Trent (LSE:SVT) is rated at Sell, reflecting a current valuation premium of 18% over its forecast regulated asset base.

The analysis comes ahead of Wednesday's deadline for companies to submit their responses to the water regulator’s draft determination, which was published in July.

Ofwat proposed that average bills will rise by £19 per year for water and wastewater companies, before inflation. These bills will be £44 lower per year than the level put forward by firms.

The regulator also removed £16 billion of proposed spending from company plans, mainly so that customers do not pay twice or for inefficiency.

It has proposed an allowed return of 3.7% on capital, which it believes will support companies to raise the finance necessary to deliver the step up in investment. Over 2025-30, water companies are expected to invest nearly £1,100 per customer in improvements.

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Ofwat, which will publish its final decisions on 19 December, said operators must ensure that any dividend payments are linked to performance for customers and the environment while maintaining adequate financial resilience.

The City’s water names trade at the high end of the dividend yield range in the UK utilities sector, reflecting the perceived risk. Pennon is the highest at 6.1%, which UBS reckons will fall to 5% in line with the two other large UK regulated stocks over the medium term.

United this month paid a dividend of 33.19p, an increase of 9.4% in line with its policy of targeting a growth rate linked to CPIH inflation each year through to 2025.

It is expected to update its financial framework and dividend policy early in 2025, once it knows the full Ofwat determination.

UBS believes that a 35 basis points uplift in United’s allowed return to 4% will be sufficient to keep the dividend sustainable and the company financeable.

It adds that getting the total expenditure United needs will be key in order to improve on storm overflows and increase regulated asset base growth towards the 20-25% of Pennon and Severn.