University of Exeter

School of Business and Economics

Academic Year: 2005/6

Module Title: Investment Analysis 1

Assignment title:

Give investment advice on United Utilities PLC

Date of submission: 18th of November 2005

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Investment advice on United Utilities PLC

Table of Contents

Table of Contents ----------------------------------------------------------------------------I

Figure ------------------------------------------------------------------------------------------- II

Tables ------------------------------------------------------------------------------------------- II

1. Company Overview --------------------------------------------------------------------- 1

2. Company profile and background ------------------------------------------------- 2

2.1. Business Overview --------------------------------------------------------------- 2

2.2. Economic key factors of the UK ------------------------------------------------- 2

2.3. Shares of the business segments ----------------------------------------------- 2

2.4. Selected aspects of sectors analyses and UU′s performance------------ 3

2.5. Major competitors -------------------------------------------------------------------- 5

2.6. SWOT analysis ----------------------------------------------------------------------- 5

2.7 Corporate Strategy ------------------------------------------------------------------- 7

3. Financial Statement Analysis-------------------------------------------------------- 8

3.1. Cash Flow Analysis------------------------------------------------------------------ 8

3.2. Ratio Analysis------------------------------------------------------------------------- 8

4. Forecasting ------------------------------------------------------------------------------ 11

5. Valuation---------------------------------------------------------------------------------- 15

5.1. Dividend Discount Model--------------------------------------------------------- 15

5.2. Free Cash Flow to Equity -------------------------------------------------------- 16

5.3. Price Multiple Valuation ---------------------------------------------------------- 17

5.4. Analysis of the results------------------------------------------------------------- 17

6. Conclusion------------------------------------------------------------------------------- 19

Appendices --------------------------------------------------------------------------------- 20

Bibliography -------------------------------------------------------------------------------- 30

I

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Investment advice on United Utilities PLC

Figure

Figure 1: Shares of the business segments in United Utilities PLC 3

Tables

Table 1: Sales growth forecast for United Utilities PLC 11

Table 2: NOPAT margin forecast for United Utilities PLC 11

Table 3: Net Debt to Capital and Net Interest Rate After Tax Ratio forecast for

United Utilities PLC 12

Table 4: Net Working Capital to Sales and Net Long-Term Assets to Sales

forecast for United Utilities PLC 12

Table 5: All forecasting parameters for United Utilities PLC 12

Table 6: Forecast Cash Flow 13

Table 7: The estimated free cash flow to equity from 2005 - 2007 16

Table 8: The average capital structure from last five years 16

Table 9: The multiple ratios from peer group 17

Table 10: The United Utilities′ suggested value of equity 17

Table 11: The mean of the three valuation methods 17

II

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1. Company Overview

1. Company Overview

U

nited Utilities PLC

Symbol:

UU.-LN (C000015834)

Great Sankey

Stock exchange market:

LON

Warrington, WA5 3LW GBR

Sector:

Multi-Utilities

h

ttp://www.unitedutilities.com

Financial Year End:

31/03/2005

GBX

Current

52 wk High

52 wk Low

P/E ratio

DY

UU LN

655.00

689.00

540.0

13.69

7.09

FTSE all share

2,730.10

2,756.75

2,342.33

14.69

n/a

FTSE 100

5,429.95

5,501.55

4,688.39

13.84

n/a

Source: http://banker.thomsonib.com

Recommendation:
HOLD

UU.-LN

Pros:

S Relatively high

performance and

lower financial risk

compared to other

FTSE all share

companies in the

water industry

S Synergy effects

through operating in

different segments

Cons:

S Dependency on

Key Financials

regulators;

Millions GBP

Y05

Y04

Y03

competition through

new regulation

Sales

2,253.90 2,060.00 1,878.80

S UU is a net

Operating Income

641.00

559.10

524.40

borrower since

Net Income

333.10

361.00

277.80

2001 in order to

Total Assets

10,108.30 9,519.40 8,391.00

being able to pay

required dividends

Total Liabilities

6,687.60 6,118.40 5,554.20

EBITDA

1,051.60 987.20

926.80

Source: http://banker.thomsonib.com 17/11/05

1

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2. Company profile and background

2. Company profile and background

2.1. Business Overview

United Utilities PLC carries out its activities through four business segments:

S Licensed multi-utility operations: United Utilities′ multi-utility operations

provide water, wastewater and electricity distribution services in the

northwest of England.

It supplies some seven million people and around

200,000 businesses with water services and about 2.2 million homes with

electricity.

S Infrastructure management: The group′s infrastructure management

business (United Utilities Contract Solutions) develops and operates

contracts applying core infrastructure management skills. It also provides

services such as multi-utility connections, metering services and facilities

management.

S Business process outsourcing: The company′s business process

outsourcing division (Vertex) provides administrative services such as billing

and dealing with customers′ enquiries.

S Telecommunications: UU provides through its subsidiary Your

Communications voice, data, mobile, and internet services.1

The company is headquartered in Warrington, UK, and had 15,935 employees in

2005. UU operates mainly in the UK, but also in the US, Canada, Australia, the

Philippines, and Europe.2 96.6% of the total turnover is generated in the UK.3 Due

to the relatively low turnover generated overseas, this report concentrates on

business activities within the UK. UU′s market capitalization is 5,683.24.4

2.2. Economic key factors of the UK

UK′s economy is one of the strongest in Europe. Inflation, interest rates, and

unemployment remain low.5 Since 1997 inflation has remained within the

government′s target range of 2.0% (see Appendix 1), and since 2000 it has been

below the euro average. Real GDP has grown strongly since 1993. Between 2000

and 2004 real GDP grew by an annual average of 2.2% per year.6

2.3. Shares of the business segments

The company′s four business segments multi-utility operations, infrastructure

management, business process outsourcing, and telecommunications accounted

1 http://banker.thomsonib.com

2 http://finance.yahoo.com/q/pr?s=uu

3 United Utilities, Annual Report & Accounts and Form 20-F 2005, page 63.

4 http://banker.thomsonib.com

5 http://www.cia.gov/cia/publications/factbook/geos/uk.html#Econ

6 The Economist Intelligence Unit Limited 2005: Country Profile 2005, pages 28-29.

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2. Company profile and background

for 54.13%, 21.24%, 15.50%, and 9.13% of 2005 revenues respectively.7 Activities

in the water utilities industry contribute the major share to the company′s revenue.

Its contribution to the total sales is about 50%.8

Figure 1: Shares of the business segments in United Utilities PLC

Telecommuni-

cations

Business

9%

process

outsourcing

16%

Licensed multi-

utility operations

54%

Infrastructure

management

21%

Source: United Utilities, Annual Report & Accounts and Form 20-F 2005, page 4.

The depth of the sector analysis depends on the share of the business segment

(see 2.4.).

2.4. Selected aspects of sectors analyses and UU′s performance

Water and electricity utility industry

The water utility industry is mature and stable, indicated by the constant growth

rate. As a result, for companies acting in the industry, sales growths are more

predictable.

The water and electricity access prices are fixed and controlled by industry

regulators OFWAT and OFGEM, respectively, at the rate of inflation plus the rate

of adjustments, called K-factor (water) and X-factor (electricity). Since access

prices are fixed, to gain more profit companies focused on that industries need to

operate more efficiently in order to lower the costs. However, companies cannot

lower its costs by degrading the quality of services because that will decrease the

rate of adjustments, which can be negative, and then decrease future access

prices.

7 Datamonitor: United Utilities, Company Profile, Sep. 2004, page 9.

8 http://www.unitedutilities.com/resources/files/650_UUW_05.pdf

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