Next Thursday, UK water companies will hear from the regulator how much they can raise prices over the next five years and what level of dividends they can pay.
There are expectations that when it announces the ‘draft determination’ for the UK water industry on 11 July, Ofwat wants to allow a handful of the most debt-laden utilities, like Thames Water, to pay lower potential fines for sewage dumping to allow time for them to “recover”.
There is also a rumour that Labour, following its predicted general election victory this week, plans to reform Ofwat, though how that will affect this ruling for the next five-year regulatory period, from April 2025 to 2030, is unclear.
Analysts at UBS said the main focus is expected to be domestic water bills, where it forecasts an average increase of £140 per year, or 31%, from £447 per average household currently as Oftwat rejects companies' requests for much higher bill increases, of above 50%.
The industry asked for a 63% increase in total expenditure (totex) in their business plans, which UBS thinks “will be more than offset by higher allowed returns”, higher than the equivalent 18% rise in 2005.
“The key debate”, says UBS, is dividends and how they are viewed by investors.
Ofwat is assuming dividends of 2-4% of base regulated equity, depending upon growth, while the listed companies Pennon Group PLC (LSE:PNN, OTC:PEGRY), United Utilities Group PLC (LSE:UU.) and Severn Trent PLC (LSE:SVT) are paying circa 5-6% at notional gearing, the analysts noted.
The regulator has stated, “we expect companies to propose adjustments to dividends” in response to higher totex.
“Yet,” says UBS, “the sector is seen by investors as a yielding sector (as seen with the circa 5% fall in Pennon shares when it reduced the dividend by circa 2.1% in May 2024 for a fine).
“It is not clear to us that the shareholder base will consider them to be growth stocks. We think this will be a key debate.”
The draft determination will be subject to consultation until 28 August. There will be a final determination from Ofwat in December this year and potentially a six-month Competition & Market Authority review in 2025, UBS said.
Pennon is the Swiss bank's top pick in the sector, rated 'buy' with an 870p share price target on its 2% discount to its forecast March 2025 regulated asset base, followed by United Utilities on a 'neutral' rating on a 3% premium and Severn Trent, rated 'sell' on a 14% premium.