New Value Analysis of United Utilities Plc 2017 (LSE:UU)
United Utilities (UU:LON)
Value Investor Analysis at price £9.65
Data from 2017 Annual report, which covers the period up to 31 March 2017.
Is the company large, prominent and important?
Market cap of £6.6 billion and total capitalisation of just over £15 billion - yes
Conservatively financed
UU has a current ratio of 0.95, which means current assets are not greater than current liabilities. This company could go bust based if all short term creditors demanded payment at the same time.
The ratio does not meet the minimum requirement of 2 to satisfy a defensive value investor, but the ratio is still respectable for a utility. As UU is a regulated utility it can normally refinance by issuing new shares or debt so the current ratio is not as important as in other industries. The current ratio has increased over the last 2 annual reports improving the margin of safety for owners of the common stock.
Total long term liabilities are £8.9 billion, and funded debt is £7 billion. The market value of the common stock is less than the value of the funded debt. The high level of debt in comparison with common stock market value would normally be a warning sign for owners of the common stock. However, a value investor in common stock will allow utilities to have higher debt levels than other business sectors. Utilities tend to have stable revenue streams and have significant physical assets to provide security for the debt.
Long term debt is more than current assets, which is normally considered a warning sign for common stock holders, but the safety of utility assets provides the protection for owners of the common stock.
Earnings before tax covers interest payments 2.18 times, which is a good ratio for defensive value investors in utility enterprises. Please see our blog post http://www.studio61wealthmanagement.co.uk/new-value-analysis-united-utilities-plc-2017-lseuu/ for more detail.
Dividend
A regular dividend has been paid for the last ten years so UU passes the defensive value investor criterion for dividends. Estimated yield, June 2017 is 4.03%. The drop in dividends after 2008 came as a result of a capital reorganisation so the dividend increases are more consistent than suggested in the chart.
Earnings
Reported earning per share needs to rise by at least one third to meet the defensive investor criteria. Earnings have risen over 239% in the last 10 years so UU meets the defensive value investor criterion for earnings growth. The average earnings per share over the last three years is £0.54. The average P/E ratio for the last three years 17.94, which suggests UU is fair value at current prices against 3 year earnings average.
Current P/E ratio on 2017 earnings is 15.2 so the P/E ratio is moderate. The current P/E is measured against a relatively high earnings level, but is some way down from the one-off high earnings in 2014. The current P/E statistic can be considered a good measure of value by value investors so the moderate valuation is confirmed.
Depreciation
| 2017 | 2016 | 2015 | |
| Depreciation and amortisation | £364,900,000.00 | £363,700,000.00 | £352,600,000.00 |
Analysis including depreciation and amortisation is not included in the defensive investor criteria, but would be appropriate for a more entrepreneurial value investor. In the case for UU depreciation is consistent so will not impact the earnings analysis. Capital expenditure in FY 2017 was £804 million, which is well ahead of depreciation, which means that the capital base is expanding, which is good for owners of the common stock.
Price to book
Price to Book ratio is 2.33 so the price is not significantly above the book value. UU meets the defensive investor criterion for book value.
Defensive Value Investor - Conclusion
UU passes all the Defensive Value Investor tests.
Entrepreneurial Value Investor- Conclusion
For the entrepreneurial value investor it is worth noting that the Return on Equity is 15.4%, which is a very good return for owners of the common stock. If the RoE number is maintained in future years high dividends and capital appreciation could be expected.
New Value Analysis of United Utilities Plc (LSE:UU)
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.
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 fairly consistent for a number of years. The earnings available to common stockholders after accounting for depreciation is good enough for defensive value investors.
Graham and Dodd also recommend that the level of depreciation is looked at critically. Depreciation has been consistent at UU for a number of years so the variability of depreciation does not impact reported earnings and so does not impact the value analysis of price versus earnings.
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. Graham and Dodd recommend that defensive value investors look for a depreciation level of 10-12% of gross earnings as a minimum. UU has depreciation of £364.9 million and gross earnings of £1.7 billion. The reported depreciation is just over 21% of gross earnings. The ratio suggests that management are being conservative in their analysis of depreciation, which is excellent news for common stockholders.
To find out if a value investor should consider an investment in United Utilities Plc common stock click here to download the new analysis.
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