Floodgates open as water giants grapple with costs: Fat dividends could be next for the chop in an industry now shedding jobs wholesale. Mary Fagan explains

IT IS nearly five years since the water industry was first exposed to the rigours of the private sector. One of the key arguments for selling off the industry was that it would be forced to become more efficient. Judging by this week's announcements, the war on flab has barely begun.

On Tuesday Anglian Water announced 900 job cuts. Yorkshire Water has also just revealed that hundreds of employees will lose their jobs before long. The scope for rationalisation seems as great as ever.

Investors must be wondering why it has taken so long to get around to stripping out the fat. If anything, water companies have recently been putting on weight. While average staff numbers dropped by 2.6 per cent in 1990-93, that was mostly the result of a 21 per cent cut by North West Water. Most companies increased their staffing levels over the period - among the excuses they give are the need to set up regulatory departments to deal with Ofwat, the water industry regulator.

Nevertheless, industry analysts now believe the price regime to be proposed by Ofwat will mean the companies having to shed perhaps a quarter of the 40,000 people employed in their core water and sewerage businesses.

They appear to have taken their time in biting the productivity bullet because they have lacked any incentive to do so. The price control formulae to which they were subjected on privatisation look extraordinarily generous. Water bills have raced ahead of inflation - and look likely to continue to do so. Ofwat estimates they could increase by almost pounds 100 a household by the end of the decade in some areas.

As a result, water companies have been able to boost shareholders' dividends in real (inflation- adjusted) terms by around 6 per cent a year, well in excess of the 3- 5 per cent in real terms that was expected at the time of flotation.

The generous send-off water companies received five years ago was justified by reference to the huge capital investment they were supposed to face on a system that had been sorely neglected.

At the time of privatisation, water companies were expected to spend about pounds 12.8bn over five years. Five years on, they have spent an estimated pounds 13bn.

But that spending has been a complex mix. On the one hand it has covered new obligations - largely quality and environmental standards decided by the European Commission. But the cost of the original programme of work has been less than expected, not least because of the lower charges levied by the recession-ridden construction industry. Driven by European legislation, investment spending will, if anything, increase over the next five years, with the 10 big water and sewerage companies in England and Wales spending about pounds 16bn.

So who will pay for this? The answer seems to be that the companies - and hence their shareholders - will have to shoulder rather more of the burden than in the past.

The fat cats in the industry are wriggling. On 28 July, Ian Byatt, director-general of water services, will deliver his verdict on new five-year price controls for the 30- plus water companies to take effect in April next year.

The controls will be tough. And the companies have no choice but to accept them or gamble on the lottery of a referral to the Monopolies and Mergers Commission.

To plug the financial gap that the new regime will leave, companies will have to accept higher debt levels, reduce payouts to shareholders and watch their share prices slide, or - horror of horrors - cut costs.

Kevin Lapwood, an analyst with Smith New Court, said: 'The whole issue of operational efficiency has never been addressed before. Now management are admitting that they can take a steamroller through the cost base.'

Nigel Hawkins, water analyst at Hoare Govett, believes that between 1995 and 2000, average increases in bills will be kept to inflation plus 1.7 percentage points. That compares with a generous RPI plus 5 today.

The controls on the companies vary according to their circumstances. Some analysts believe the worst-off could see prices capped to less than inflation. But the consensus is that if they bite the bullet on costs, the companies will still be able to increase dividends in real terms.

Shareholders in some of the companies have urged them to consider the MMC route. But those pondering the prospect of a monopolies inquiry might have been wiser to demonstrate that efficiency, not just profitability, had been the focus of their attention.

----------------------------------------------------------------- Manpower changes* 1990/91-1992/93 ----------------------------------------------------------------- % Anglian . . . . . . . . . . . . . . . . . . . . . . .+9 Northumbrian . . . . . . . . . . . . . . . . . . . . 10 North West . . . . . . . . . . . . . . . . . . . . .-21 Severn Trent . . . . . . . . . . . . . . . . . . . . .- Southern . . . . . . . . . . . . . . . . . . . . . . +7 South West . . . . . . . . . . . . . . . . . . . . .+16 Thames . . . . . . . . . . . . . . . . . . . . . . . -6 Welsh . . . . . . . . . . . . . . . . . . . . . . . .+1 Wessex . . . . . . . . . . . . . . . . . . . . . . . +7 Yorkshire . . . . . . . . . . . . . . . . . . . . . .-6 *Excluding acquisitions ----------------------------------------------------------------- Source: Hoare Govett -----------------------------------------------------------------

----------------------------------------------------------------- Water companies' dividend growth 1989/90-1994/95* ----------------------------------------------------------------- six-year real growth total per annum % % Anglian . . . . . . . . . . . .61.2 . . . . . .6.1 Northumbrian . . . . . . . . . 65.8. . . . . . 6.9 North West . . . . . . . . . . 59.2. . . . . . 5.8 Severn Trent . . . . . . . . . 66.3. . . . . . 7.0 Southern . . . . . . . . . . . 66.3. . . . . . 7.0 South West . . . . . . . . . . 57.2. . . . . . 5.5 Thames . . . . . . . . . . . . 68.0. . . . . . 7.2 Welsh . . . . . . . . . . . . .65.3 . . . . . .6.8 Wessex . . . . . . . . . . . . 68.3. . . . . . 7.3 Yorkshire . . . . . . . . . . .61.5 . . . . . .6.2 *Actual dividends 1989/90-1993/94. Forecast dividends 1994/95 ----------------------------------------------------------------- Source: Hoare Govett -----------------------------------------------------------------

(Photograph,graph and table omitted)