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You have been asked by a consultant to examine United Utilities Group PLC (stock code UU.), a UK based Water and Waste Utilities company.
The consultant has asked you to comment on a number of issues relating to the group from its 2013 annual report and accounts (see the following pages: http://annualreport2013.unitedutilities.com/).
You have been asked to put your comments in a report of no more than 3000 words :
(Total marks 100)
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The United Utilities Group PLC is UK's largest water company. It is not only a regulated water supply giant, but also has a massive wastewater management network operational in North West England. In terms of growth and customer satisfaction, United Utilities is well renowned and invests in not only their business but also in people, assets and worthwhile processes. UU Group is an attractive investment opportunity for most shareholders because it has good operational efficiency and the earnings per share have increased by nearly 11%.
For any company to grow and make investments, the debt management plays a key role. In their vision, United Utilities speaks of being one of the best in the UK for water and wastewater management. Their decisions over the years reflect this. Right from raising debt to managing inevitable bad debts, United Utilities has come a long way. The company believes in conducting business at the lowest possible sustainable costs. They do not minimize their expenses at the cost of employee welfare. Employees and customers are views as long-term assets for the group. Amidst a dynamic regulatory structure, United Utilities has to respond to the various regulatory changes that are introduced by the UK government. Since United Utilities has to follow policies set by OFWAT, it becomes very important to have cordial relations with the regulatory bodies.
(Question a is answered in this part)
Some of the key observations from the 2013 annual report are given below.
The underlying operating profit has risen by 2.2% over the financial year. Underlying profit after tax is a measure which deducts net expenses and taxation from the underlying profits has also gone up by 10.5%. The Earnings per share as mentioned have increased by almost 11%. The level of gearing for the financial year 2013 was at 60% which stood at 1% higher than the previous financial year. This is a small change but a positive sign. The gearing which is a measure of the group's net debt upon the equity capital, at 60% lies well in the range of OFWAT (55-65%). Gearing plays an important role when it comes to company ratings and calculation of financial stability in the firm. 60% gearing for United Utilities group can boost returns on capital as they increase the investing ability of the firm. (2013)
The group's operating cash flow needs to be constantly managed because there is always a volatility factor related to floating electricity prices and other operating costs. The operating cash flow for the financial year ending 2013 stood at £852 million which helped to partially offset the increase in expenditures such as dividend payments, taxations and pension deficits' repair payments. The principal amount of the index linked debts was also on a rise. Higher operating cash flow helps in managing a lot of these expected and unexpected increases. The liquidity requirements of short term can be met using operating cash flows. The United Utilities group has a lot of index-linked debt. This implies that, with increasing inflation, their financial costs also increase. The net value of debt at the financial year ending 2013 was £5,451 million. This value was £375 million more than the previous financial year. Operating cash flows help in managing this to a great extent. As mentioned in the annual report, the United Utilities group had fixed its nominal interest rate at approximately 5% for the period 2010-2015. Interests paid out potentially drain the cash flows of any firm. United Utilities had this vision in mind and so they formulated their hedging policy for interest rates in 2009.
(Question b)
Bullet bonds are also known as vanilla bonds. They are redeemed on a predetermined maturity date. In fixed-rate bullet bonds, the rate of interest is fixed through the life of the bond. The advantages of fixed rate bullet bonds are that they allow the issuing party to reinvest the principal amount of the bond on other projects. These bonds are highly preferred as the interest is fixed and secured. The interest is paid regularly and this takes the pressure off the issuer since it helps to improve cash flow. Furthermore, no bond is risk-free. There is always a cost that is attached to earning returns in the long run. A low-risk bond providing a 6% rate of interest is more attractive than a high-risk bond providing 8% return. Fixed rate bullet bonds have disadvantages as well. They turn out to be expensive because the interest on the principle which is outstanding is fixed. There is a credit risk that is attached to such bonds. The bulk risk lies in the repayment during maturity. This principle amount is a debt that has to be paid.
Pricing of a bullet bond is done using the simple concept that when we buy a bond, we are assured that we receive regular payments during the bond's tenure in the form of interest and the principle amount is paid during maturity. This implies that at a present date, we pay up the present value of all the future cash flows that we receive. (Henrard, 2013)
