London, July 15 - Water companies could see dividend pressure next week if the sector's regulator permits them to make returns which do not match their capital expenditure plans.
Every five years the water regulator OFWAT rules on how much money the companies can make, and on July 23 it will issue its draft opinion for the period 2010 to 2015.
Water companies are seen as reliable dividend stocks, but as the economic recession puts pressure on revenues, next week's prices ruling by OFWAT could force some companies to cut payouts to shareholders.
The decision will include the amount of capital expenditure that the regulator believes each company needs to make, the levels they can increase their bills by, and the permitted return, which will be a single overall figure applied to all companies.
If the return is at odds with the capital expenditure, then companies might need to cut their dividend to help cover the shortfall.
"It might be that the capital expenditure is so high that at constant gearing you might have to fund the equity proportion of it through retained earnings. In that case, the dividend will have to come back," said Lakis Athanasiou, an analyst at Evolution Securities.
"The one that is exposed to that ... is United Utilities because of the debt and where they are on dividends at the moment," he said.
He said that Pennon, which owns South West Water, was well placed because it also had its Viridor waste business to draw from.
Analysts at Merrill Lynch agree that United Utilities is at the greatest risk from the price review.
They point out that the company's waste water plans are skewed towards enhancement, rather than base service, and therefore could be downsized.
They see Northumbrian Water as having the lowest risk because the business plan is uncontentious and focussed on the company's customers.
Mark Freshney at Credit Suisse said he saw Severn Trent being at the highest risk because of the cost of its debt and the level of its dividend.
"(At) Severn Trent the cost of the dividend is pretty much 2.7 percent of regulated asset value, whereas United Utilities adjusting for (a range of) factors is 2.6 percent," he said.
RETURNS
In business plans submitted in April, companies requested that OFWAT approves a post-tax Weighted Average Cost of Capital (WACC) -- which is the return they can get from their assets.
The range of requests are 4.7 percent for Northumbrian Water, 4.76 percent for Pennon's South West Water, 4.85 percent for United Utilities and 5 percent for Severn Trent.
Athanasiou predicts that the figure will come in at 4.5 percent, or 5.2 percent on a pretax basis, Freshney sees it coming in at 4.6 percent and Merrill Lynch also see it coming in below this range.