United Utilities, Severn Trent, and Pennon Group constitute the three best UK water stocks to watch in 2023, despite the complex cocktail of incoming headwinds.

3 best UK water stocks to watch in 2023

Water is rarely thought of as a commodity, but this may change very soon. A hallmark of commodities trading — including oil, gold, and wheat – is that they must be scarce, and cost money to produce or extract.

While water does indeed cost money to purify and pump into homes and businesses, it’s not yet thought of a scarce global resource. However, UNICEF research shows that four billion people, almost two-thirds of the world’s population, experienced water scarcity for at least one month a year. Further, 50% of these people live in a country where the overall water supply is inadequate.

And climate change could drive this trend further. Summer headlines saw rivers and reservoirs dry up across the globe, including the Danube, Yangtze, Rhine, and Colorado.

Even in England, which typically spends over a third of the year being hit by rain, reservoirs hit just 65% of their total capacity in July, their lowest level since 1995, with drought declared in eight areas.

More importantly given the current investing climate, water stocks are possibly the most defensive companies available to trade on the market. Every single person on the planet must drink water every single day, and with the world’s population set to increase to 10.4 billion people by 2100, water is likely to become an increasingly valuable commodity, even if supplies are managed responsibly.

In the past, water has been owned and operated by governments, to make sure that access to the resource remained universal and fairly priced. However, many countries, with varying rates of success, have turned to privatisation as public ownership has not been able to fund the innovation needed to meet the challenges of water management.

On the one hand, this has led to increased investment and development. But on the other, critics argue that placing profits over the public provision of uniquely positioned universal need has created problems including reduced reservoir building and increased leaks, in order that private companies can pay out dividends.

However, these companies can be excellent investment opportunities. The UK is seen as particularly attractive, as it has privatised the entire market, while most other countries operate private-public partnerships. Of course, no system of management is perfect, highlighted by the recent reports of sewage discharge into the sea and major rivers across the country.

For ultimate diversification, many investors buy shares in a global water ETF, such as the iShares Global Water UCITS ETF, which follows the S&P Global Water index. The index has direct investments in the world’s 50 largest water companies.

Of course, some prefer to buy individual stocks to attempt to beat the average market return.

3 best UK water stocks

3 best UK water stocks

United Utilities

United Utilities (LON: UU) shares have been falling fast since mid-August due to worse-than-expected financial results. However, this may provide a buying opportunity as at 911p, UU now offers an attractive 5% dividend yield. And the water stock is still up 10% over the past five years, demonstrating the defensive strength of water.

The FTSE 100 company delivers 1.8 billion litres of water a day to more than 3 million addresses in Northwest England and has boasts advanced sensors into its pipe system to help detect leaks early.

Roughly 50% of its water supply comes from Cumbria and Wales, which historically features few water supply problems. Further, the company is usually hailed as the largest corporate landowner in England, with 56,000 hectares under ownership.

Severn Trent

Severn Trent (LON: SVT) shares are down 18% year-to-date to 2,413p, buffeted by the same inflationary headwinds as United Utilities. However, the company could now be undervalued, given its strong overall growth, relatively impressive environmental credentials, and disciplined focus on outcome delivery incentives.

And like United Utilities, it’s up 15% over the past five years, a healthy return for a defensive stock. The company serves roughly 4.5 million addresses across the Midlands. And it operates within the catchment area of both the Severn and the Trent, two of the UK’s largest rivers, ensuring uninterrupted supply for years to come.

Moreover, the company is already delivering the lowest bills in England and Wales until 2025, making further government-forced concessions unlikely.

Pennon Group

At 823p, Pennon Group (LON: PNN) shares have more than halved since the pandemic began and are now at their lowest price point in 12 years. Pennon is the smallest of the UK’s three water stocks, though its South West Water, Bristol Water, and Bournemouth Water divisions together serve more than 2 million people.

The company sold Viridor in July 2020 for £4.2 billion, a solid growth opportunity, to better invest into its core water business. Pennon is also spending heavily on renewable energy, recently revealing a detailed £160 million plan to generate half of its own energy needs by 2030.

However, elevated inflation is increasing the cost of Pennon’s debt. A third of its £3.2 billion debt pile is index-linked, so every 1% increase in inflation is adding around £8 million in interest costs. And with energy bills set to soar in April, a double whammy of increased costs and debt payments could send it tumbling further.

This article has been prepared for information purposes only by Charles Archer. It does not constitute advice, and no party accepts any liability for either accuracy or for investing decisions made using the information provided.

Further, it is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.

Charles Archer is an experienced financial writer specialising in monetary law. With a background in stock market and private equity analysis, he’s worked for many years as a freelance investment author,...

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