View from City Road: Backwash time for water companies

Water may drop free from the skies, but dividends do not. Shareholders in the water companies would do well to remember that as they cross off the days to 28 July.

The water industry is on the threshold of a period of considerable upheaval. As Welsh Water's falling dividend cover demonstrated yesterday, the effortless growth in dividends enjoyed over the last five years - around 6 per cent per annum in real terms, rather than the 3-5 per cent expected on privatisation - will soon disappear forever.

At the end of next month, the 'k' factors, already fixed by Ian Byatt, director general of Ofwat, will be revealed. They will determine by how much (or how little) individual water companies will be able to raise their prices over the next five years and they are going to be much tougher than the industry has enjoyed thus far.

With prices more tightly constrained the only way water companies can meet their commitment to real dividend growth will be by improved efficiencies or allowing dividend cover to slide. So far the water companies, whose corporate culture remains stubbornly that of a nationalised industry (albeit one with highly remunerated directors), have shown little will for taking the axe to their businesses.

Diversification isn't going to help either, judging by experience so far. As the records of Welsh and, more especially, Northumbrian and Severn Trent, demonstrate, lack of both management skills and sufficient opportunities mean this route is more likely to soak up profits than to create them.