United Utilities (UU.) has increased its interim dividend by 2.2%, in line with management's policy of increasing the dividend in line with the U.K. retail price index. The utilities firm today reported half-year operating profit of £342 million, up 13% from half-year 2016. This is roughly in line with the 12% growth that equity analysts expect over the full year.
As a result, Morningstar equity analysts are reaffirming our £9 per share fair value estimate for United Utilities Group, along with our narrow economic moat and stable moat trend ratings.
The key driver of the operating profit growth is regulatory revenue increases and efficiencies. Revenue grew 3%, reflecting allowed regulatory revenue increases. Underlying operating costs were reduced by £9 million in the first half, despite rising inflation. Controllable costs are 10% below the 2010 level, reflecting good efficiency performance. Net profit grew 5.7% to £160 million, as earnings before tax growth was partially offset by a £29 million increase in finance expense due to higher inflation of the index-linked debt.
Investment opportunities drive our modest earnings growth forecast. Management recently identified an additional £100 million in resiliency investments, which is incremental to our estimated £3.5 billion capital investment forecast. The additional investment doesn't have a material impact on our fair value estimate, but additional regulated investments support regulatory rate base and earnings growth.
Investment Thesis
Much of Britain's water infrastructure is more than 200 years old and could require major upgrades during the next decade. We project that United Utilities, which is one of 11 UK water utilities, will invest roughly £825 million annually during the next five years in its water and wastewater system to address these needs. Regulators in Britain approve capital budgets and utility rates once every five years based on utility budget forecasts.
Utilities then must stay within that budget to achieve sufficient rates of return. United Utilities' regulated water-distribution monopoly leads us to assign the firm a narrow economic moat, a phrase used to denote competitive advantage over peers.
But we caution investors to beware of execution risk in Britain's five-year price reviews, as the company must meet performance targets, along with the threat of continued conservation. Given the recent events in the UK, investors must now also worry about an uncertain political future in the country.
