Three of the LSE’s major water firms, United Utilities Group PLC (LON:UU.), Severn Trent PLC (LON:SVT) and Pennon Group plc (LON:PNN), all saw their shares dip on Wednesday after Ofwat unveiled plans for stricter financing requirements.
The water regulator said in a report on Tuesday that a package of measures aimed at strengthening the “financial resilience” of water firms, including restrictions of the payment of dividends to shareholders if necessary.
Rachel Fletcher, Ofwat’s chief executive, said the new measures would give “greater assurance to customers” about the financial stability and “long-term resilience” of the companies.
The prospect of a regulatory strait-jacket on pay-outs causes a big issue for the publicly-listed water firms, which are often viewed as ‘income stocks’ meaning they attract investment through reliable and hefty divi payments rather than the prospect of gains in the share price.
If these disappear under the new requirements, which will force water companies to maintain an ‘investment grade’ credit rating by locking up certain amounts of cash, the one thing supporting investor interest in these stocks could vanish along with it.
While new measures aren’t due to come into effect until next April, investors already seem a little jittery, with shares in United falling 0.3% to 791.8p in late-afternoon trading while Severn dropped 0.1% to 2,076p and Pennon slipped 0.4% to 761.8p.
The prospect of even more regulation also piles the pressure on a sector that has already been under the cosh amid criticism over rising bills, executive pay and the taking on of debt to satiate the demands of investors.
There is also the looming threat of renationalisation, with the Labour party having already floated plans in May to bring the water companies back under public ownership.
Benefits drying up?
With perhaps the most well-known benefit from the water firm’s stocks seemingly in jeopardy, could the shares be heading for an exodus of investment?
An analyst at a multinational investment bank was relatively unphased, telling Proactive that the new guidelines “weren’t really that new” and were more or less priced into the stocks following a consultation launched by Ofwat last year.
He added that most of the regulatory pressure had come from unlisted water firms, and that those on the stock market were having to adhere to stricter rules than their peers already.
“In terms of the way the industry is trending…it was broadly expected”, he said.
The sentiment that any potential regulatory pressure was already priced in was echoed by Laith Khalaf, an equity analyst at Hargreaves Lansdown, who said that the risk of renationalisation by a potential Labour government was more likely to be weighing on the minds of shareholders.
“[Renationalisation] is still hanging over utilities and that has depressed sector,” Khalaf said, adding that while he didn’t think the dividend risk was anything new, he couldn’t see much of a value opportunity in the shares either.
“Politics is unpredictable at the best of times, and this isn’t in many people’s books the best of times”, he said.