Water Bills rise in price - I still think its cheap

Posted on Thu 02 December 2004 in Business

Today, OFWAT (the government body that ensures the water companies in the UK are acting responsibly) announced that water bills will be rising across the UK. The news media all started saying how bad it was and that the water companies made 1.4 billion (or some such figure) and therefore didn't need to raise the prices anyway. As is typical with the media when they report this type of story, they fail to mention half the relevant facts. So, lets go find them on the internet and come to our own conclusion (or at least, you'll get to read my opinion).

So first of all, what are the price rises?
The following table comes from the BBC news site, and originally from OFWAT.

Water and sewerage
Company 2004/05 2009/10 Rise
Anglia 294 313 7%
Northumbrian 232 260 12%
Severn Trent 221 265 20%
South West 357 444 25%
Southern 259 324 25%
Thames 210 261 24%
United Utilities 269 322 20%
Welsh Water 286 352 23%
Wessex 276 347 25%
Yorkshire 243 288 18%
**Source: Ofwat**

That table tells a lot. To begin with, look at the column titles. 2004/5 compared to 2009/10. That's a five year period of time. The Rate column shows the difference as a percentage. When I first read the table I assumed they were comparing current prices with the new prices for next month - not prices as they will be in 5 years time.

So, what are we going to be paying this time next year?
(I'll take just Southern Water from now on as they supply me. It's also one of the highest rises).
324 - 259 = 65 rise over 5 years = 65/5 = 13 a year.

13 a year is a 5% rise. Yes, just 5% for the most dramatic rise across the water industry. Lots of things increase in price by 5% during a year and if my memory serves me inflation is about 3% (and a quick internet search gave me one result of 2.6%) - so Southern Water prices are increasing faster than inflation. I also know that the world price of Steel is increasing a lot faster than UK inflation too but perhaps the media don't research it or publicise it because people on the street don't go and buy Steel (they buy finished products which use steel some of which I know have increased in price around 8%).

The thing to remember is that inflation is calculated by looking at all the things a country buys, and what happens to the prices over time. Lots of things affect it. Raw material prices, Labour costs (If you get a pay rise you are increasing the national inflation rate, take a pay cut and you are decreasing the rate) as well as market forces (competition between business can drive prices down and inflation goes down with it. Technology like the internet has made many business processes cheaper which in turn can lead to cheaper market prices and therefore lowers the inflation rate). Pitty the poor people who live in the Anglian water area, having to suffer a less than 1% price rise.

One more thing I've just discovered. The price rises through the year are in addition to inflation. In other words the cost of supply water is expected to be increasing relative to the supply of other products in society. So the 13 a year may well increase by another 3% if inflation stays the same, which is a stagering total 13.39 pence a year. (appologies for the irony - I just can't resist!)

OK, so we know the increase is not a lot. It's still going up and essentially the water companies operate a monopoly. Are they just raking in the cash? Will the 1.4 Billion of profit be given to the shareholders and the poor customer made to pay more?

Lets find out.
1) Financial Reports for Southern Water. Should be able to find those on the internet...

Didn't take long to find. (Statutory Accounts 2003/2004)

What does it tell me?
Last year they lost 8.1 million. That in itself doesn't mean a lot, just that what they did make was paid out to shareholders as Dividends. Dividends were 66.5 million from a turnover of 455 million. A margin of around 14% which would be very low for a small business but for bigger businesses sounds fairly reasonable to me.

What else?
In order to run that company, they use assets worth 3,500 million pounds. Here's a question for you. Would you put a 100 pound in the bank as an investment if you were only going to get 102 pounds back at the end of the year? Probably not, especially as the earnings aren't guranteed. That's what the Official accounts of Southern Water are saying. Remember also that 66 million pounds probably doesn't go very far if you need to build a new sewage works.

Of course, it's not quite as bleak as that. Some of the business is funded by its owners (the share holders) but other funding comes from finance companies and suppliers. Leased equipment (so the Water Company don't own the equipment but they pay a rental each month for its use) doesn't appear in the books as an asset, it's an expense. EG The company probably doesn't own the Managing Directors company car - they hire it.

The share holders provide about 1,000 million pounds in order to run the company. Using the 100 pound in the bank analogy its getting a return of 6.6% which is a bit more healthy. On those figures, more people would probably risk their money in the company. Now to buy a piece of that company so you can get your 6% may cost more than value of the assets you're buying. That's why the share price of a company is not neccessarily related to the value of a company, its related to how much you're willing to risk to get a return. If you had to pay 300 pounds to get a 100 pounds of the company (and therefore a 6.60 dividend for your 300) it becomes less attractive. Now I'm moving off topic, so back to the main question -

Are the water companies earning too much money? I think the 14% margin says no, especially as the directors have to maintain a margin or lose their jobs (the share holders expect to get something for risking their money) and if they can't charge enough to do that, the first thing that stops is long term investment (that will be another share holders problem, the current group of share holders would take the profits and sell their shares before the value dropped).

As for the price rise above the rate of inflation, I also think that's OK because the company needs to spend more than the current rate of inflation in order to provide a service into the future.

Just my 10cl though - let me know what you think....