The Investment column: Possible drain on profits threatens Anglian Water level

The Investment Column

ANGLIAN WATER has a provincial name and, despite having a host of international interests, is a provincial company. Ninety per cent of sales come from its drinking water and sewerage businesses in England and Wales, which is regulated by Ofwat. Being largely regulated can be a good thing for a company; it means earnings are solid and easy to predict. So Anglian's shares, in common with most water stocks, have tended to track the FTSE. Towards the end of last year, Anglian's attraction as a defensive stock saw it outperform the market by 30 per cent.

But this year it has underperformed to the same degree. The market's switch to cyclical stocks has made Anglian less appealing as a defensive holding. Meanwhile, Ofwat is expected to impose on the privatised water companies some price cuts on 27 July. This uncertainty undermines Anglian's status as a stock which doesn't have surprises in the pipeline.

Operating profits in the water and sewage business fell from pounds 364m to pounds 292m last year, out of pounds 357m group profits. Ofwat is expected to make Anglian and others give customers a sharp one-off price cut to achieve fair charges over the next five years. Anglian opposes this because it will have to raise prices later to meet Ofwat's requirements on capital expenditure, which totalled pounds 347m this year. Ofwat, however, wants prices to be set according to annual investment targets, rather than averaged over the period. Depending on the outcome, Anglian may appeal to the Monopolies Commission. The significance for Anglian is that it would be less able than its larger peers to absorb a one-off hit. Anglian's interest cover is less strong than Thames Water's.

Of Anglian's pounds 829m turnover, pounds 104m comes from its international operations. These made a loss before interest of pounds 5.6m. Its US joint venture generates $40m (pounds 26m) and could perhaps provide double digit growth. Meanwhile Anglian has proved it can beat off the likes of Enron in securing new water contracts in Chile. But these are neither credible nor significant sources of non- regulated revenue. Charterhouse Securities forecasts pre-tax profits of pounds 278m and earnings of 94.5p this year, with a 47.9p dividend. The forward p/e of just 7.5 reflects uncertainty surrounding Anglian's path to growth. Investors may nevertheless wish to hold the stock for its 6.75 per cent yield.