Last week’s UK inflation figures were bad.
The consumer price index (CPI) is rising at 4.5% a year. The retail price index (RPI) – which includes housing costs, and is often seen as a better cost-of-living gauge – is rising at 5.2% a year.
Put like that, the figures may not sound too painful. But believe, me, they are.
Look at it another way: 5.2% annual inflation would halve the ‘real’ value of your cash in less than 14 years.
That’s why we’ve been writing a lot recently about ways you can protect your savings from inflation. And for those who don’t mind a little bit of stock market risk, here’s another.
How can you stop your savings being eroded?
John Stepek gave out some ideas on inflation protection last week. And in this week’s issue of MoneyWeek magazine, Tim Bennett looks at a couple of intriguing bonds that offer inflation protection. (If you’re not already a subscriber, subscribe to MoneyWeek magazine.)
But how about getting an inflation-busting income stream from the stock market? Now is a good time to look at this topic, because it’s ‘water utilities’ week. The big players in the sector are reporting their results right now. Historically, these stocks have been some of the best dividend payers in the UK market.
Tuesday saw South West Water owner Pennon (LSE: PNN) release full-year figures. Britain’s largest-listed water utility United Utilities (LSE: UU/) reported yesterday, while results from Severn Trent (LSE: SVT) were out today. Next Tuesday it will be the turn of Northumbrian Water (LSE: NWG).
So what’s the story? It’s been a mixed bag. Pennon says its waste management business is doing very nicely. Profits in that unit were up 14%. Water distribution, though, isn’t doing quite as well. Profits at South West Water dipped slightly.
Mind you, they’d have been very happy to announce those results over at United Utilities. There the management has had to admit to a fall in underlying pre-tax profits of almost a third, on sales that were 3% lower.
The problem has been the regulator. Ofwat has been putting the squeeze on. Leakage targets have been steadily tightened – and failure to meet them means being fined up to 10% of turnover. But even worse for water suppliers, the effects of Ofwat’s 2009 price controls are hitting prices and profits.
In fact, United Utilities has had to cut its full-year dividend by 12.5%. Severn Trent – whose underlying pre-tax profits took a 15% hit – has sliced its pay-out by 10%. In a nutshell, although not exactly a surprise, this isn’t great news if you’re holding these stocks for their dividend pay-outs.
Sure, the worst of the dividend damage should have been seen for the moment. Analysts expect a more upbeat tale – and a higher dividend payment – to emerge from Northumbrian Water next week. Further, water utility bosses generally are talking about being able to raise their pay-outs again in future. So it’s not all gloom income-wise for shareholders in the sector.
This sector offers better value than water stocks
But water shares have recently done rather well. Severn Trent, for example, is up by 45% over the last 18 months. And this has raised stock valuations on average to the mid-teens, which looks rather high for basic utility businesses. So selling out of the sector now seems to make sense.
Is there a better bet around? We’ve been banging the drum about defensive sectors – which don’t need economic growth to make money – for several months now.
One area that still catches our eye is power supply. Major UK electricity and gas provider Scottish & Southern Energy (LSE: SSE) has done well since our recommendations last year. But it’s still on a forecast current year p/e of just 12.5, while the 5.5% prospective dividend yield beats even that 5.2% RPI rise.
National Grid (LSE: NG/), which owns and operates Britain’s high voltage electricity transmission network looks even better. The forecast current year multiple is a tad lower, while the prospective yield, at 5.9%, is even higher.
And if you’re quick, you can still pick up the final dividend of 23.47p a share, which alone is equivalent to a 3.8% yield. But for that you’d have to buy the stock today, because it goes ‘ex’ that dividend – ie you wouldn’t get it – on Monday (note that the stock price will then drop back to reflect this).
So much for the short-term. What about the longer run? Here we’re tracking not just yield, but dividend growth too. Look at this chart.
Source: Bloomberg
The first line to note is the black one. This is Britain’s CPI going back to the start of 2006, just before inflation began getting worse again. As you can see, since then UK average prices have climbed by around 17% in total.
The other lines show – as marked – the cumulative dividend growth of the stocks I’ve been writing about today. In other words, if you’d been invested in Severn Trent over that time, the dividends you’d have received would have lagged inflation by some way. United Utilities’ payments have fallen even shorter.
Meanwhile Northumbrian Water’s payout has beaten CPI, but not by much. Yet National Grid and SSE – in particular – have both shot the lights out.
OK, their share prices can be volatile. And no equities are risk-free. But these two stocks have the track record. First, they deliver inflation-busting yields. And second, their dividends are likely to grow much faster than the CPI. Right now, that looks good to me.
Another big fan of blue-chip dividend payers is Stephen Bland, who writes The Dividend Letter. In fact, his whole investment strategy is built around them. If you’re looking for a straightforward, low maintenance, low stress way to invest and build an income for the long run – and let’s face it, who isn’t? – then you really should have a look at this presentation here, which gives more details on his strategy.
Category: Market updates