New Value Analysis of United Utilities Plc (LSE:UU) 2021

Published by Jonathan Taylor at 25th January 2022

New Value Analysis of United Utilities Plc (LSE:UU) 2021

A new value analysis of United Utilities Plc (LSE:UU), a company listed on the London Stock exchange, has been added to our research pages here. This link could go to the new page you build or to a new product I the Shop – but the Shop is not working right now so can you take a look at the shop?

United Utilities holds a licence to provide water and sewage services to around seven million people in North West England. These services regulated by the UK water regulator, Ofwat. United Utilities manages the water and wastewater infrastructure and the environment across North West UK, including the following assets.

Over 42,000 kilometres of water pipes, from Cumbria to Cheshire
Over 76,000 kilometres of sewers
569 wastewater treatment works
94 water treatment works
Over 56,000 hectares of catchment land

Why would a value investor consider an investment in United Utilities Plc?

The value analysis of UU demonstrates a number of features that are common to most utilities. Some of the financial features of utilities can be distracting for value investors. Specifically, utilities tend to have higher debt levels than would normally considered appropriate for value investors.

The 1940 version of Security Analysis on page 169 has this to say about utility investing.

… the most important idea associated with a public utility is that of stability, based first upon the rendering an indispensable (and generally exclusive) service to a large number of customers, and, secondly, upon the legal right to charge a rate of compensation sufficient to yield a fair return on the invested capital.

The stability is relative rather than absolute but does mean that owners of the common stock retain a margin of safety even if debt levels are higher than would be acceptable for other types of enterprise.

Benjamin Graham and David Dodd have some specific advice for investors in Public Utilities in Chapter XII of the 1940 version of Security Analysis. This chapter is aimed at bond investors, but applies equally to investors in the common stock of utilities. Graham and Dodd recommend that the depreciation statistics be analysed in assessing the defensive nature of an investment in utilities.

The depreciation statistic for UU has been consistent for a number of years. The earnings available to common stockholders after accounting for depreciation is good enough for defensive value investors.

Moreover, earnings can be analysed after the assessment of depreciation. On this basis UU has sufficient earnings to make capital expenditure and pay dividends to owners of the common stock.

One final element is to review depreciation in relation to gross earnings, meaning earnings before tax and any special items including depreciation. Graham and Dodd recommend that defensive value investors look for a depreciation level of 10-12% of gross earnings as a minimum. In its 2020 Annual Report, UU has depreciation of £422.3 million and gross earnings of £1.02 billion. The reported depreciation is just over 41% of gross earnings. The ratio suggests that management are being conservative in their analysis of depreciation, which provides a level of safety for common stockholders.

The price action of the stock can be seen in the chart below.