Utility investments in hot water – how this impacts your wealth

“Our turnaround plan is going to be a long and challenging journey spanning eight years, so managing our finances efficiently is crucial.”[i]

Alastair Cochran, Chief Financial Officer, Thames Water

October 2022

If you’ve been keeping up with business news, you’ll have seen that Thames Water’s turnaround plan isn’t going well. It is only human to wonder what impact this may have on your investments in utilities.

The company appeared to be weathering criticism about sewage in our rivers and on our shorelines. Chief executive Sarah Bentley, appointed in 2020, was overseeing a transformation of the company, with a revamped leadership team.

Tidal surge

But then, on 27 June, Bentley resigned. And, the share price plunged from 101.5p to 94.3p.

Newspaper reports talked of, “an emergency plan to nationalise Thames Water,”[ii] “crisis talks over potential £10bn black hole,”[iii] “huge resistance from investors,”[iv] and “a tidal wave of problems” after “years of neglect”[v].

Thames Water continues to talk of its strong financial footing: £4.4bn in cash and committed funding, an injection of £500m from equity investors, and that turnaround plan.[vi]

But nationalisation – bringing the company back into public ownership, for the first time since 1989[vii] – remains a live topic.

Clearly, we have no idea what will happen; nor does anyone else at this stage, though it doesn’t stop speculation.

It seems sensible to aggregate what we know and what it might mean for your wealth management and investments in utilities.

Flooded with debt

The story of privatised water companies is chiefly one of borrowing from credit investors to pay shareholder dividends. They started off with £0 in debt in 1989 and by 2022 it had reached £60.6bn[viii].

Some £13.41bn – or almost a quarter of the 17-strong water sector’s debt – currently comes from Thames Water. This looks disproportionate.

Thames Water hadn’t paid a dividend for five years, because it was focused on servicing this borrowed money. For every £1 received from bill payers, 8p would go to its lenders[ix]. You probably don’t need me to point out the Bank of England base rate is 5% (or 5p in £1). Rates spent much of the last five years at 0% and 0.75%[x]. Thames Water appear to be paying a remarkably high rate on their borrowings.

Utility Investments: a traditionally stable sector?

The case for investing in utility companies – a sector also including gas, electricity, and telecoms – is based on a story of strength and stability.

These are essential services. You can’t really choose whether to have them or not. Apart from those in extreme circumstances, people keep paying bills. Such a metronomic income sets utilities apart from, say, consumer companies like FTSE100-listed Ocado or Burberry.

This gives them resilience in economic downturns. A firm like Sainsbury might struggle in a downturn (and it certainly has since 2019, compared to the FTSE100), not so utility companies… or so the wealth management argument goes.

But, if we go back to the debt for a moment, rising rates push up the cost of paying interest on debt (let alone repaying the debt itself). About half[xi] of the Thames water debt was on a floating interest rate, that rises with the incoming tide of Bank of England rates. No wonder there’s been no money to pay dividends to shareholders.

Following the evidence for utility investments

If there’s one lesson from this sorry tale, it’s that selecting individual shares is a risky business.

Perhaps some of the big shareholders in Thames Water – like the giant UK pension fund for university lecturers – looked at Thames Water’s debt pile and worked out the impact of rising interest rates on their investment. But such analysis is a stretch for busy people with utility investments who want the best for their wealth.

Putting eggs into a single share could expose you to risks like this. It’s something history – and evidence – shows time and again.

For effective wealth management, we feel it is far better to buy a large basket of shares (which may include utility investments), diversified across countries and sectors, with a bias towards things the evidence suggests is likely to do better over the longer term – like good value firms or smaller companies – and leave them alone. Our view is: the only time you tinker is if your goals change.

The rest of the utilities sector may fit the strong and stable narrative.

We’d rather look more broadly at things that we feel could really grow your wealth, than narrowly at those which might hole it below the waterline.

[i] https://www.thameswater.co.uk/media-library/home/about-us/investors/our-finances-explained.pdf

[ii] https://www.telegraph.co.uk/business/2023/06/28/whitehall-draws-up-emergency-plan-to-nationalise-thames-wat/

[iii] https://www.theguardian.com/business/2023/jun/28/thames-water-in-crisis-talks-over-potential-10bn-black-hole-cost-possible-collapse

[iv] https://www.ft.com/content/573a8996-327c-4c9d-adc9-429c3e37fc37#post-504b0df5-22f9-4484-8703-d462932565bc

[v] https://www.thetimes.co.uk/article/thames-water-fights-to-escape-a-tidal-wave-of-problems-2mcfbh08h

[vi] https://www.thameswater.co.uk/about-us/update-from-us

[vii] https://www.ofwat.gov.uk/regulated-companies/ofwat-industry-overview/#:~:text=The%20ten%20publicly%20owned%20water,put%20on%20hold%20in%201986)

[viii] https://www.ofwat.gov.uk/wp-content/uploads/2022/12/MFR_2021-22.pdf

[ix] https://www.thameswater.co.uk/media-library/home/about-us/investors/our-finances-explained.pdf

[x] https://www.bankofengland.co.uk/boeapps/database/Bank-Rate.asp

[xi] https://www.ofwat.gov.uk/wp-content/uploads/2022/12/MFR_2021-22.pdf

This document is marketing material for a retail audience and does not constitute advice or recommendations. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.