Company analysis

  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

  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  

1. Company Overview

1. Company Overview

Symbol: UU.-LN (C000015834) U nited Utilities PLC

Source: http://banker.thomsonib.com

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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

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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2. Company profile and background The water act 2003 (WA2003), which will be implemented on 1 st December 2005 9 , will give opportunities for competition in the water industry in England and Wales. The main aspect is that water supply licensees will be able to provide retail supply (the supply of water purchased from a water undertaker) and water undertakers are obliged to allow licensed water supplier to use (rent) its network. Companies within the water industry are facing increasing costs in terms of environmental compliance to new EU directives. Investment is a key issue, shown by United Utilities who are carrying out the largest single investment program in the history of the UK water industry. Whilst such investments could prove profitable in the long-term, they are degrading margins in the short-term.

OFWAT has provided companies with an incentive to increase their investiture into the UK water distribution infrastructure. OFWAT allowed companies to match any significant cost increases with a rise in prices.

The compound annual growth rate (CAGR) of the water utility industry in the UK of the last four years was 3.3%. In the period 2004-2009, the CAGR is predicted to be 4.3% (see Appendix 2). 10 Turnover increased by 10.3% per cent in 2004/05 and by 5.9% in 2003-04 11 , largely due to a real increase of 8.9% and 4.0%, respectively, in water and wastewater prices.

Infrastructure management industry

That industry has real growth opportunities as companies continue to seek new ways to deliver cost-effective services. In terms of UU, recent contracts such as significant contracts with Welsh Water and Scottish Water confirm the growth opportunities. Turnover in UU’s infrastructure management business increased by 21.5% in 2004-05, compared with an increase in turnover of 12.5% in 2003-04.

Business Process Outsourcing industry

The increasing trend towards outsourcing is evident from the high growth year after year of the global market for outsourcing. As price competition intensifies, firms have to differentiate themselves. Possible differentiation strategies are a high quality consultation or initiatives such as free consultation. The leading players have tended toward acquisition. Recently, Vertex acquired a US based debt collection agency (First Revenue Assurance) to gain a foothold in the US utilities collections market, and Marlborough Stirling PLC, a provider of outsourcing services and technology to clients in financial services. In 2004-05 Vertex increased its turnover by 7.6%, compared to 19.8% in 2003-04. 12 9 www.ofwat.gov.uk 10 Datamonitor: Water Utilities in the UK, Industry Profile, July 2005, pages 13-14. 11 United Utilities Water PLC: Annual Report and Accounts 2004 and 2005 12 United Utilities, Annual Report & Accounts and Form 20-F 2005, pages 19-21.

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2. Company profile and background

Telecommunication industry

The telecommunication industry is growing, but fiercely competitive. OFCOM, the independent regulator and competition authority for the UK communications industries, is currently undertaking a strategic review of the UK telecommunications industry. In 2004, Your Communications acquired Eurocall to strengthen its position. In the Annual Report 2005, UU stated to possibly sell the telecommunication business when shareholder value can be maximised.

2.5. Major competitors

Due to the unique structure of UU, it is difficult to set up a peer group with the same structure. In this evaluation, three competitors were chosen which are most similar in the structure to UU and key players in the water utility sector:

2.6. SWOT analysis

13 Datamonitor: Water Utilities in the UK, Industry Profile, July 2005, page 14. 14 http://banker.thomsonib.com

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2. Company profile and background

Strengths

Synergy effects

UU set up three business segments in order to increase efficiency and add more value to the company. The structure of UU enables the company to improve the efficiency of its regulated businesses by maximising synergies as a multi-utility operator. UU grows its support services by applying its core skills of its support businesses in competitive markets. 15 The infrastructure management business applies its skills to tasks in the group, such as contract negotiation and utility network construction. Vertex handles administrative functions, such as billing and costumer management for the company. Your Communication develops and operates internal communication for the company.

Beside synergy effects, all segments add value to themselves by offering their services to the market.

Technology development

The group is committed to use cost-effective and practical solutions for providing high quality services. UU recognizes the importance investments in the development of technology, that it has the right skills to apply technology to achieve sustainable competitive advantage.

Increasing revenues expected

Revenues increased for fiscal 2005 by 9.4%, and between 2006 and 2008, a growth forecast of 6.9% (CAGR) is expected (see 4.). 16 Growth in earnings from licensed multi-utility operations business is complemented by growth in the non- regulated activities (see 2.4.).

Weaknesses

High Capex

United Utilities has a very heavy Capex program in its water business. The company has a high level of expenditure, and at the same time it is expected to pay its shareholders high dividends. UU is borrowing money (perhaps by around £100 million per annum) to pay the expected dividends. In the worst case, this may lead to in solvency of UU at sometime in the future.

Communications contribution

In 2005, Your Communications’ continued to contribute segmental operating losses to the group due largely to high marketing costs and fierce competition. But this business managed to reduce segmental operating losses for the year and achieved break-even in the second half of the year.

15 http://www.unitedutilities.com/?OBH=214&SCH=strategy&ID=0 16 Datamonitor: United Utilities, Company Profile, Sep. 2004, pages 22-26.

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