Is United Utilities Group the Ultimate Retirement Share?

LONDON -- The past five years have been tough for those in retirement. Portfolio valuations have been hammered and annuity rates have plunged. There's no sign of things improving anytime soon, either, as the eurozone and the U.K. economy look set to muddle through at best for some years to come.

A great way of protecting yourself from the downturn, however, is by building your retirement fund with shares of large, well-run companies that should grow their earnings steadily over the coming decades. Over time, such investments ought to result in rising dividends and inflation-beating capital growth.

In this series, I'm tracking down the U.K. large caps that have the potential to beat the FTSE 100 over the long term and support a lower-risk income-generating retirement fund (you can see the companies I've covered so far on this page).

Today, I'm going to take a look at United Utilities  (LSE: UU  ) (NASDAQOTH: UUGRY  ) , the water and sewage utility that serves over seven million people in north-west England.

United Utilities vs. FTSE 100
Let's start with a look at how United Utilities has performed against the FTSE 100 over the last 10 years:

Total Returns

2008

2009

2010

2011

2012

10-Year Trailing Average

United Utilities

(11.6%)

(15.6%)

26.1%

7.6%

16.6%

7%

FTSE 100

(28.3%)

27.3%

12.6%

(2.2%)

10%

9.6%

Source: Morningstar.

(Total return includes both changes to the share price and reinvested dividends. These two ingredients combined are what make it possible for equity portfolios to regularly outperform cash and bonds over the long term.)

United Utilities' 10-year average trailing total return shows that it has underperformed the FTSE 100 on a total returns basis over the past 10 years. The group's underperformance doesn't surprise me very much, given that it seems to have had a bit of an identity crisis during this period. Over the past 10 years, United Utilities has bought and sold a 15% share in Northern Gas Networks, sold its electricity distribution business, disposed of a range of other non-regulated businesses and carried out a 1 billion pound rights issue to raise cash.

Today's United Utilities is a different business to that of 10 years ago, but for retirement investors, United's sole focus on the regulated water and sewage sector could be good news, as it provides an attractive and consistent business that should generate a healthy stream of dividends.

What's the score?
To help me pinpoint suitable investments, I like to score companies on key financial metrics that highlight the characteristics I look for in a retirement share. Let's see how United Utilities shapes up:

Item

Value

Year founded

1989*

Market cap

5.0 billion pounds

Net debt

5.8 billion pounds

Dividend Yield

4.5%

5-Year Average Financials

Operating margin

35.3%

Interest cover

2.6x

EPS growth

(2.8%)

Dividend growth

(11.3%)

Dividend cover

1.2x

*United Utilities was originally called North West Water Group and was formed when North West Water was privatized in 1989.

Here's how I've scored United Utilities on each of these criteria:

Criteria

Comment

Score

Longevity

A young company, especially after all its restructuring.

2/5

Performance vs. FTSE

Average at best.

3/5

Financial strength

Heavily geared, but operating margins are strong.

3/5

EPS growth

Earnings remain below 2011 levels.

3/5

Dividend growth

A cut in 2010 means dividends remain at 2009 levels.

3/5

Total: 14/25

It's worth noting that the reason all U.K. utilities carry a lot of debt is because the regulatory pricing regime allows them to reclaim the cost of the debt and a profit margin through customer bills, as long as borrowings are invested in their networks to increase their regulated capital value. This means that it is to shareholders' advantage for utilities to remain highly geared, as it enables them to pay more generous dividends than they would otherwise be able to -- even though this might not result in the cheapest rates for customers.

My verdict
At present, United Utilities shares provide a dividend yield of around 4.5%, well above the FTSE 100 average. However, the demand for yield is so high at the moment that United's shares currently trade on a forward price-to-earnings ratio of 18.5, above the FTSE 100 average of 16.5 and close to United's all-time high.

Water utilities will begin a new regulatory price control period in 2015, and the level of the new pricing controls hasn't yet been decided, which could cause some pressure on both share price and dividends over the next few years. I don't think that United Utilities is a buy at present -- and I reckon that there are much better opportunities for retirement investors elsewhere in the utility sector, one of which I discuss in more detail below. I'd recommend you take a look.

2013's top income stock?
The utility sector is known for its reliable, above-average dividends, but The Motley Fool's team of analysts has identified one FTSE 100 utility share that they believe offers a particularly high-quality income opportunity.

The company in question offers a 5.7% dividend yield, and the Fool's analysts believe that it could be worth up to 850 pence per share -- offering new investors a potential 20% gain on the current share price of around 700 pence.

Indeed, The Motley Fool's analysts are so confident in this share that they've named their report "The Motley Fool's Top Income Stock For 2013"! This exclusive new report is completely free but will be available for only a limited time -- so click here to download your copy now.


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