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UK inflation is picking up fast. Official figures out today show consumer prices rising 2.3% year on year in February. The retail price index rose 3.2%. Now most economists use CPI, but RPI is still relevant for water utilities. RPI helps decide how much your water bill goes up and how much their dividends might rise. And the regulator uses it to decide how much profits water companies are allowed to make.
All that should make their shares a pretty good inflation hedge. But such protection comes at a price. And whether you think it is worth paying depends rather on what you're comparing it to. This chart shows the average yield on shares in Severn Trent and United Utilities, two of the biggest water companies in the UK. It compares it to the yields on the FTSE 100 index and on the 10-year Gilt. Notice how utilities now yield less than the stock market as a whole - not more - but they still look pretty compelling when compared with bonds.
That begs the question, are utilities as stable as bonds? Well, they are very defensive. Pressure on discretionary spending is not going to make us take fewer showers or wash our clothes less. And though they have a lot of debt, much of it isn't fixed rates, so they're not vulnerable to rising interest rates. The big uncertainty is regulation. Returns are determined in five year blocks and the next of those starts in 2020. Already, there is clamour for lower returns and more competition. If you're a pension fund, like the one that bought a quarter of Thames Water last week, you can take a long view of that. But investors with shorter time horizons should think about regulation as well as reflation.
