For investors looking for passive income, the water industry sounds like a dream – a monopoly with a captive customer base. And earlier this month, Andy Burnham seemed to reiterate this view.
The Prime Minister told the House of Commons that “the shareholders can never lose and the bill payers never win.” But if this is winning, I’d hate to see what losing looks like.
Who’s winning?
Pennon Group (LSE:PNN) owns South West Water and SES Water, and the stock comes with a 6.2% dividend yield. Sounds great.
Unfortunately, it’s hard to see how investors have been doing anything that might be described as winning recently. The stock’s down roughly 64% over the last five years.
Obviously however, Burnham isn’t talking about share price movements – he’s focused on dividends. But adding them back still reveals a total loss of around 50%.
Not every water stock is the same. Severn Trent shares have returned around 20% in that period, roughly in line with the FTSE 250.
Most businesses would kill for a monopolistic position in a service where demand never disappears. But it’s hard to see the sense in which shareholders can’t lose.
The bit people underestimate
Burnham’s definitely onto something in the court of public opinion – the water industry has a reputation for underinvesting while raising bills. Whether or not that’s fair is another question.
Water regulator Ofwat has various clawback mechanisms. These include Price Control Deliverables and the Delayed Delivery Cashflow Mechanism, that return money to customers when promised work doesn’t arrive.
Water companies are also explicitly required to weigh service performance, investment needs, and financial resilience before declaring a dividend at all. So they don’t have it all their own way.
The more awkward question is underperformance, not underinvestment. Pennon took a £42m penalty last year and earned a 6.7% return on regulated equity.
On top of this, the share count has risen 65% in a year after shareholders funded a £490m equity raise at a 35% discount. All of this makes the dividend look uncertain to me.
Final thoughts
It’s easy for shareholders to blame management – after all, the politicians are doing it for entirely different reasons. But that’s also unfair in some ways. The regulatory bar has gone up and financing costs have increased. Both of those are real challenges and there’s not much a CEO can do about either.