United Utilities: fit to keep holding?

[Breelander]

... it looks like CEO and CFO have received new shares under a bonus scheme and they've both sold a big chunk, roughly half of what they received to cover tax...

That seems to be common practice. Over the years I've seen similar bonuses and disposals for tax payment in many of my holdings.

[Arborbridge]

Thanks for the input so far. As you will realise, I use this forum as a "sounding board" and I'm grateful for the advice received, which usually keeps me on the straight and narrow as regards the HYP path. Sometimes a little reassurance is required, even if one has been doing this for a decade or more.

Owing to the weighting of UU - currently 0.66 of median - I might soon have to decide whether to dispose of it or top up, along TJH's lines, by setting a you-know-what which dare not speak its name. However, although there's no hurry what prompted me to ask was a bout of pre-Brexit nerves allied to the fact that this week I've been enjoying a free trial with Simply Wall street in which UU comes up covered in red! This lead to my looking further into the accounting numbers and was not amused by what I saw as regards cover and increasing debt.

As regards an earlier question: I've bought a new holding in D S Smith in time for the XD date.

Arb.

[Gengulphus]

As regards the accounts and sustainability: does the lack of free flow worry you? or the increasing debt?

As I indicated, as long as gearing and other debt ratios aren't worsening (which I think you said is the case, at least for gearing), I'm not worried about the increasing debt - it's only growing as the company grows, and that's only to be expected in a utility business that basically needs to have that sort of gearing level and has the revenues to service it.

As far as free cash flow is concerned, I've never found a method of calculating it that I find satisfactory - every way runs into the problem that some capital expenditure simply maintains the current value of the business (so doesn't increase its value to shareholders), while the remaining capital expenditure enhances it (which does), and the accounts generally don't give a breakdown of the overall capital expenditure into the two. The purpose of free cash flow is to measure the cash flow that is producing new value for shareholders, so that's a rather fundamental practical problem with calculating it. In short, it's a good measure in principle, but not very practical!

So I'm not confident about my own ability to calculate a fit-for-purpose free cash flow figure even with detailed study of a company report, and so generally don't bother trying. Nor am I confident about the ability of free data sources to calculate one, since I very much doubt that they're either using people with at least my abilities or doing as prolonged study as I would. (I don't doubt that they have such people, indeed ones with much greater ability than me, and that those people do the detailed study - but I do very much doubt that they hand those people's analyses out for free!)

The other thing I would say about that is that there are numerical reasons why calculations of free cash flow become less reliable as the level of capital expenditure rises. To see why, a highly oversimplified example - imagine two companies with the following details:

Company A: Basic cash flow = £2b, capital expenditure £1.5b, estimated split 80% (£1.2b) maintenance, 20% (£0.3b) enhancement, so free cash flow = £2b-£1.2b = £0.8b.

Company B: Basic cash flow = £4b, capital expenditure £4b, estimated split 80% (£3.2b) maintenance, 20% (£0.8b) enhancement, so free cash flow = £4b-£3.2b = £0.8b.

I.e. they have the same calculated free cash flow and the same estimated split of capital expenditure - it's just that company B has higher capital expenditure requirements and the higher basic cash flow needed to fund them. But if the 80%:20% split is a misestimate and it's really 90%:10%, then company A's free cash flow drops to £2b - (£1.5b * 90%) = £0.65b, while company B's drops to £4b - (£4b * 90%) = £0.4b. Or if it's really 70%:30%, then they instead rise, to £2b - (£1.5b * 70%) = £0.95b and £4b - (£4b * 70%) = £1.2b. So the same range of maintenance:enhancement capital expenditure split misestimates produces ranges of free cash flow figures with high and low ends that differ by a factor of just under 1.5 for company A, but 3 for company B.

So I would regard calculated free cash flow figures as especially unreliable for capital-intensive companies like United Utilities.

Gengulphus

[Gengulphus]

... it looks like CEO and CFO have received new shares under a bonus scheme and they've both sold a big chunk, roughly half of what they received to cover tax...

That seems to be common practice. Over the years I've seen similar bonuses and disposals for tax payment in many of my holdings.

I have received shares myself under a similar type of scheme (as a senior employee rather than a director) and so can say from personal experience that it is indeed common practice: the organisation my employer used to run the scheme automatically sold the right quantity of shares (*) to cover higher-rate tax and National Insurance Contributions, and the details went through into my payslips. I'm not certain whether I could have said "No, don't sell the shares - I'll pay the tax from my own resources and keep the shares" - but the documentation I received didn't give any hint that that was possible or how to go about it if it was, so letting the shares be sold was certainly the line of least resistance, and I didn't try to do anything else.

(*) Just under half, though I don't remember the exact percentage - but the last time was about a decade ago, and there have been enough tax changes since that that exact percentage is doubtless out of date!

Gengulphus

[Arborbridge]

As regards the accounts and sustainability: does the lack of free flow worry you? or the increasing debt?

As I indicated, as long as gearing and other debt ratios aren't worsening (which I think you said is the case, at least for gearing), I'm not worried about the increasing debt - it's only growing as the company grows, and that's only to be expected in a utility business that basically needs to have that sort of gearing level and has the revenues to service it.

As far as free cash flow is concerned, I've never found a method of calculating it that I find satisfactory - every way runs into the problem that some capital expenditure simply maintains the current value of the business (so doesn't increase its value to shareholders), while the remaining capital expenditure enhances it (which does), and the accounts generally don't give a breakdown of the overall capital expenditure into the two. The purpose of free cash flow is to measure the cash flow that is producing new value for shareholders, so that's a rather fundamental practical problem with calculating it. In short, it's a good measure in principle, but not very practical!
So I'm not confident about my own ability to calculate a fit-for-purpose free cash flow figure even with detailed study of a company report, and so generally don't bother trying.
So I would regard calculated free cash flow figures as especially unreliable for capital-intensive companies like United Utilities.

Gengulphus

Thank you for this interesting input, and I apologise for hacking your post in the above quote.

You confirm my on feelings on the subject, and I too always wrestled with trying to decide which was maintenance and which was capex which would bring added benefit in the future. Even if one makes a reasonable stab, investment capex might prove worthless. An example I always think of is supermarkets where new store openings could be allowed as investment to enhance the business - but what happens if the stores do not get opened or are not profitable? It happened in recent years when supermarkets changed tactics in the type of stores they decided to open. leaving some as white elephants. As Warren Buffett wrote, words to the effect that if there is large capital investment, one needs to be jolly sure that there is a pay off down the line. (I always found it strange that he bought a capital intensive railway line!)

I suppose the answer to that dilemma is to subtract all Capex and hope the number give by the accounts or data source includes maintenance. One is then on the cautious side, but it may also be quite unfair.
It's frustrating that this vital piece of information - the division between two types of CAPEX is often not mentioned at all.

Free cash flow can therefore only be an indicator at best - used as you say alongside net gearing or increasing debt as a reality check.

Arb.

[Gengulphus]

Owing to the weighting of UU - currently 0.66 of median - I might soon have to decide whether to dispose of it or top up, along TJH's lines, by setting a you-know-what which dare not speak its name.

For me there would be a third option: do nothing with it! And that's what I'm doing. When I last looked, the holding's income and capital value are 0.56 * average and 0.64 * average respectively, so broadly similar to yours. That made it rank highly on inverse capital value, but somewhat below middling on forecast yield, resulting in it being 12th out of 40 in my top-up order, which was low enough that it probably wouldn't be the chosen candidate for top-up. But it probably wouldn't have mattered anyway, because the current political risk means that while I'm not unhappy about my utilities weighting, I'm not very keen to increase it either. As a result, I wouldn't be very keen to increase my holdings of the more obvious political targets among my utilities, and so I've got United Utilities flagged in my spreadsheet as "think hard before topping up even if it rises to position 1 (and then probably don't!)".

But it's a small enough holding and doing adequately well. So the net result is that I'm not selling, and almost certainly not buying, for as much of the future as is foreseeable. Which isn't much right now, but it does include getting their final results on May 23rd, which should make a much more up-to-date analysis of the company possible than it is now... At the moment, we've only got their trading statement last week, and that's clearly been selective about which figures it presents (not necessarily bad, but whether it is depends on how they've done the selecting, which is unknown). So I'll be waiting at least until they're out before taking more than a cursory look (which I've done, and it hasn't produced anything I find very alarming, given the capital-intensive nature of the company, nor anything brilliantly good-looking).

Gengulphus

[Dod101]

If the point has not been covered, one way of breaking down capex is to look at the figure for depreciation. That is supposed to cover the capex simply to keep the business turning over. It is a rough and ready measure but so are many of the figures you see in a set of accounts and at least it gives a measure of the expenditure needed for that purpose. The other fundamental point is to try to ensure that dividends are being met by available cash generated after all capex.

But I agree that it is difficult to get a grip of in a very meaningful way.

Dod

[tjh290633]

Owing to the weighting of UU - currently 0.66 of median - I might soon have to decide whether to dispose of it or top up, along TJH's lines, by setting a you-know-what which dare not speak its name.

For me there would be a third option: do nothing with it! And that's what I'm doing. When I last looked, the holding's income and capital value are 0.56 * average and 0.64 * average respectively, so broadly similar to yours. That made it rank highly on inverse capital value, but somewhat below middling on forecast yield, resulting in it being 12th out of 40 in my top-up order, which was low enough that it probably wouldn't be the chosen candidate for top-up. But it probably wouldn't have mattered anyway, because the current political risk means that while I'm not unhappy about my utilities weighting, I'm not very keen to increase it either. As a result, I wouldn't be very keen to increase my holdings of the more obvious political targets among my utilities, and so I've got United Utilities flagged in my spreadsheet as "think hard before topping up even if it rises to position 1 (and then probably don't!)".

I'm a bit puzzled by this. My holding is 112% of the median value and the yield is virtually at the median. I topped up after the 2008 B-shares issue and consolidation, at 448p in October 2009. I topped up twice last year at 770p in January and 700p in October, and the current price is 815p. Obviously it was top of the midden for topping up back then.

In January it ranked second after MKS and I was reinvesting the proceeds of trimming IMI, then at 1425p. GSK was teh third recipient. In October I had just come back from a month-long cruise, and had a lot of dividends to reinvest. That time VOD ranked first, BATS second and IMB third.

What puzzles me is why the subject didn't come up last year when the price was down at 700p.

TJH

[csearle]

...since I very much doubt that they're either using people with at least my abilities or doing as prolonged study as I would. (I don't doubt that they have such people, indeed ones with much greater ability than me, and that those people do the detailed study - but I do very much doubt that they hand those people's analyses out for free!)

I feel I am to you as Donkey is to Shrek. C.

I suspect that this might well be off-topic and deleted. I would not complain.

[Arborbridge]

What puzzles me is why the subject didn't come up last year when the price was down at 700p.

TJH

That's a good "rational" point - and it oftens happens when people post "I'm thinking of ....x,y,z, action", and I think a similar thought to you.

The truth is that this was kicked off by two things: a perceived increase in the political risk which caused the price to drop last week, combined with a free subscription to Simply Wall Street which got me thinking about UU. accounts. It seems to be one of my weakest shares for debt and cash flow as highlighted by Simply Wall St and confirmed by other investigations.

In short, it was top of my mind last week, but wasn't six months ago - as simple as that.


Arb.

[Walrus]

What puzzles me is why the subject didn't come up last year when the price was down at 700p.

TJH

That's a good "rational" point - and it oftens happens when people post "I'm thinking of ....x,y,z, action", and I think a similar thought to you.

The truth is that this was kicked off by two things: a perceived increase in the political risk which caused the price to drop last week, combined with a free subscription to Simply Wall Street which got me thinking about UU. accounts. It seems to be one of my weakest shares for debt and cash flow as highlighted by Simply Wall St and confirmed by other investigations.

In short, it was top of my mind last week, but wasn't six months ago - as simple as that.


Arb.

Funnily enough a post TJH posted a couple of months ago 're his historic yields on shares had me looking at UU as a candidate that may need action. Historically it has had significantly higher yields from what I could see, and in my eyes is actually expensive right now relatives to other ftse candidates . Last year it was some what in the doldrums yielding just shy of 5.5 percent and I had no issue with it. Now when the water regulators are intimating they will be cracking down on returns and we have the political fun It made sense to swap out for something I deemed better value.

[Arborbridge]

Funnily enough a post TJH posted a couple of months ago 're his historic yields on shares had me looking at UU as a candidate that may need action. Historically it has had significantly higher yields from what I could see, and in my eyes is actually expensive right now relatives to other ftse candidates . Last year it was some what in the doldrums yielding just shy of 5.5 percent and I had no issue with it. Now when the water regulators are intimating they will be cracking down on returns and we have the political fun It made sense to swap out for something I deemed better value.

Maybe, it's not such a surprise, then - it's just that I'm a bit late in the game! I always was a slow tinkerer.

Arb

[tjh290633]

Never mind the quality, feel the width!

It hasn't cut the dividend. Labour might never happen and if it does, the market might not react the way it supposes.

Time for masterly inaction in my view.

TJH

[Gengulphus]

What puzzles me is why the subject didn't come up last year when the price was down at 700p.

HYPers aren't all that well-known for carefully watching the capital values of their holdings! ;-)

Gengulphus