Thames Water, with occasional cameos by ugly little siblings Southern Water and South East Water, grabs most of the attention in the sector for obvious reasons. So it’s easy to overlook what’s happening further north. Short answer: the new era of higher bills and higher spending on water infrastructure will feel splendid if you’re United Utilities, licence-holder in north-west England, or Severn Trent, operating in the Midlands.
The former’s share price surged 11% on Thursday, the sort of thing that shouldn’t happen at a utility where success is meant to be defined in terms of dull predictability. And it’s definitely unusual to see a one-day valuation jump of that size when the company is issuing £800m-worth of new shares.
Indeed, there was a mini-stampede for UU’s equity after Australia’s sovereign wealth fund, Future Fund, and the global infrastructure investor Atlas grabbed half the allocation in the placing as “cornerstone” investors.
Why the rush? Well, it is because Ofwat’s regulatory settlement a year ago on prices – the one that shoved up water bills across England and Wales – looks more generous than imagined back then.
Or, at least, it looks more attractive for a certain subset of firms: those that aren’t clocking up huge fines for pollution year after year, notwithstanding UU’s woes at Windermere.
There were two critical numbers in UU’s strategic update that accompanied the placing and full-year results. First, the company is targeting a return of equity of 10-11% in the current five-year period, a full percentage point above previous guidance.
The difference may sound modest, but double-digit returns ain’t bad at all, especially when they are underpinned by bills that rise with inflation. Some City analysts had been forecasting a return rate of 8.5%.
Second – and this was the more surprising bit – UU thinks it can go back to Ofwat and be allowed to spend another £2.5bn, on top of an agreed £9bn until 2030, because the regulator’s last assumptions did not take account of all the houses and datacentres the government wants to build around Manchester.
The first £1.4bn slug of spending would mean bills going up by another £10 per household if Ofwat says yes. And, for UU, the overall £2.5bn would mean its asset base growing at 10% a year to 2030, instead of at 7%. Those recast growth numbers also explain the share price rise: for utilities, the pure size of the assets is the first entry in the valuation box.
UU’s shares have now improved 30% in a year, outpacing the FTSE 100 index. Severn Trent was pulled 7% higher in sympathy on Thursday, probably on the thought that it, too, will be able to pitch some “reopeners” to Ofwat. Amid the crisis in the water sector, both companies’ shares stand at all-time highs.
Outrageous in the context of the wider crisis in the sector? Well, before damning Ofwat too severely for over-generosity to companies, one should probably concede that the regulator produced roughly what the Labour government, opposed to nationalisation, wanted: a more investor-friendly set-up to ensure infrastructure gets built. That was the implicit bargain, even if ministers sometimes struggle to admit it as they launch ineffectual “clampdowns” on bonuses.
Note, too, that five other water companies still reckoned Ofwat had been too mean to them on bills and appealed to the Competitionand Markets Authority. Most secured small upwards adjustments to bills, which was close to an endorsement of Ofwat’s original arithmetic.
But one can still say that the crisis at Thames seems to have worked to the advantage of the likes of UU and Severn Trent, the two standout financial outperformers of recent years (and two of the only three that are still on the stock market).
In the regulatory and political panic over Thames, the regulatory dial was turned further than it appeared a year ago. Not everyone benefits, but, for the relative winners, the financial rewards look relatively bigger.
There is also a lesson for the government, still (like Ofwat) navel-gazing over what to do about Thames. If the corporate calamity is tipped into special administration, shareholders won’t flee en masse from the water sector. Rather, international investors seem keen to throw capital at the right firms.