US Edition United Utilities
455¼p -¼p
Questor says Hold
United Utilities updated the market on Wednesday ahead of its half-year results in November.
The only news of real note in the statement related to tax. United said it would receive £50m in tax rebates as a result of settling prior years' tax returns with HM Revenue & Customs.
It is understood that the company's full-year tax payment is likely to be only a very small cash outflow, which makes its balance sheet about £100m healthier than most analysts thought.
Having raised £220m of debt this year, cover for projected financing needs now stretches out to the second half of 2011.
The net interest United pays on its debt is fiendishly complex to calculate. But, as much of it is linked to inflation, that should also come down this year.
Otherwise, the company was looking forward to the water regulator Ofwat's final determination of prices for the 2010-2015 period, due in November.
History suggests that this will be more lenient than Ofwat's draft proposals. So, where the regulator has suggested water companies will be able to make a return of 4.5pc on their asset base, it may finally decide to settle on the 5pc that industry players have been lobbying for.
United expects first-half operating profit for the regulated part of the business to remain flat compared with the same period last year. Businesses, particularly the industrial businesses in the North West where United is focused, are using less water as a result of the downturn.
This means that the 6pc price increase that United is allowed by the water regulator Ofwat will not translate into a 6pc increase in revenues but something closer to 4pc.
United is also suffering from rising electricity bills. The company says the price of electricity, used to run its treatment works, is likely to increase by 10pc in 2009-2010.
The update also makes passing reference to bad debts, which are running at a rate of about 3.5pc of its regulated revenues. A company spokesman is quick to play down the threat of an increase in bad debts, but it is one area Questor is a little concerned about.
The recession has been keenly felt in the region United works in. Companies going bust or simply not paying their water bills is likely to lag other consequences of the recession, and United's bad debt rate could rise significantly this year.
Elsewhere, the company expects a "marginal" increase in operating profits in the non-regulated business, which sees United run bits of other people's companies.
It mentions a three-year contract win with Southern Water to manage the design and construction of a new wastewater and treatment works in Brighton.
On the downside, United's contract to manage Scottish Water's capital investment programme comes to an end in March 2010. Rival Veolia is the most likely party to pick up the contract, which generated revenues of £40m a year, with an estimated 5pc margin. Its loss will inevitably result in a small dent to revenues in that part of the business.
Questor recommended buying United as an income stock back in July. The company said the dividend policy depended largely on Ofwat's final determination. Questor thinks the balance sheet is in sufficiently good shape that the dividend structure will be maintained, so these shares are worth keeping in the portfolio.
Yielding 7.5pc, the shares are trading on a March 2010 earnings multiple of 8.1 times.
Game Group
171¾p -½pp
Questor says Avoid
Game Group, the computer games and consoles retailer, is definitely one to avoid. The group said yesterday that half-year profits plunged by 67pc, from £32.8m to £10.8m. Like-for-like sales fell by 16.3pc.
The retailer has seen a few years of staggering growth and is up against strong comparative figures. Also, the cyclical computer games sector is "mid-cycle", meaning that no new consoles have been released for a while now.
To give the company credit, the interim results were in line with its guidance to the market.
On top of this, the overall computer games market has actually declined at a greater rate than Game's sales.
However, turnover is still below last year's level (despite recent console price cuts starting to come through) and we remain cautious on the outlook.
Game said yesterday that this year is all about margin and not sales. Indeed, the management team increased its full-year gross margin guidance to between 170 basis points and 220 basis points (up from between 150 basis points to 175 basis points previously).
But margins across the industry could come under pressure if software prices fall.
There are also some competitive pressures in the shape of HMV Group, which has moved heavily into gaming, and the ever-present threat of the internet.
There is also a long-term threat of the digital downloading of computer games. This could have the same impact on the traditional computer games market that the digitisation of music had on the CD market.
It would have a severe impact on high-street games retailers, although everyone in the industry agrees that this technology is some way off.
Game has a dividend yield of 3.5pc and trades on a price to earnings ratio of 7.2pc. Although they are cheap, Questor is not tempted to buy.