Most Overvalued FTSE Stock

THE VALUE INVESTOR: United Utilities is rated as a one-star stock by Morningstar analysts, meaning it is trading at significantly more than its Fair Value share price

Emma Wall 26 March, 2014 | 2:57PM
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Successful investment is all about timing. Knowing when to be brave, and pick up a cheap stock down on its luck – and knowing when to trim a holding, take profits and sell a company that has made you money.

United Utilities (UU.) is rated a one-star stock by Morningstar analysts. Morningstar equity analysts use qualitative and quantitative research to determine a share’s Fair Value, and from this they award it a star rating. A stock with a five star rating is trading at significantly less than its Fair Value – and one that has been awarded one star is considered by analysts to have a share price much greater than the Fair Value estimate.

United is the only one-star stock listed on the UK stock market; analysts consider a fair value of the company to be £5.89 a share, but today it is trading at around £8 a share.

United Utilities Group is primarily a holding company for United Utilities Water, the country's largest regulated water and wastewater utility serving nearly seven million customers in northwest England, including Manchester and Liverpool.

Equity analyst Andrew Bischof says that United will have large expenditure over the next couple of years, which affects the value of the shares.

“Much of Britain's water infrastructure is around 200 years old and could require major upgrades during the next decade,” he said. “We project that United Utilities, which is one of 11 U.K. water utilities, will invest roughly £2.2 billion between fiscal 2013 and 2016 in its water and wastewater system to address these needs.”

Without achieving cost savings and efficiencies, the company will have a hard time earning more than its cost of capital, says Bischof.

Management has underperformed some of regulators' operational targets in the last few years, which hurts shareholders because of the regulatory pricing structure.

“The latest rate review was ugly, lowering rates by more than 4% in 2011 with little growth through 2015. This could signal a shift toward the rate payer in regulatory policy,” added Bischof.

The inflated share price may be a signal for value-focused investors to reconsider their holding in the company, but for income investors United is still attractive.

United pays an inflation-busting yield of 4.07% - one of the top paying stocks on the FTSE 100. And the stock does have a kind of monopoly on the water sector.

“The company's balance sheet is filled with cheap debt financed for 30 years and beyond, which should boost returns on equity for many years,” said Bischof.

“With non-regulated operations gone, United Utilities is essentially a pure-play on Great Britain's regulated water sector.”

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
United Utilities Group PLC1,044.00 GBX0.48Rating

About Author

Emma Wall  is former Senior International Editor for Morningstar