Thames looks back on course; The Investment Column

Thames Water never resists an opportunity to crow about how its bills are the lowest in the UK while, almost alone among the privatised water companies, it managed to get through the summer with no restrictions on supplies. So much for customers. The story for investors has been rather less crystal clear.

The crux of the problem was the company's disastrous foray into international contracting, which culminated in the abrupt resignation of chief executive Mike Hoffman earlier this year and restructuring provisions of pounds 95m. In the shake-out which followed Thames sold 60 per cent of its non-regulated businesses, which since privatisation had managed to accumulate losses of pounds 70m and a lot of bad feeling among shareholders.

Yet all of a sudden things seem to have turned the corner. The pounds 225m share buyback in July did a lot to help, of course, and losses in the remaining foreign operations have been cut back from pounds 6.3m in the first half of last year to pounds 1.6m in the same period this year.

Finally the penny seems to have dropped in the executive boardroom that it makes little sense to dish out shareholders' cash in risky diversifications when most investors would prefer to sit back and enjoy guaranteed dividends from the regulated domestic utility business.

A sounder explanation of this core strategy from the management is winning back the analysts. As one put it yesterday, "I've been negative about the stock for as long as I can remember, but for the first time I'm turning more positive."

True, the 15 per cent surge in profits to pounds 188m in the six months to the end of September came mainly because earnings last year had been depressed by losses in the non-core contracting businesses. True also that about half of the 22 per cent dividend increase is accounted for by the share buyback, which spread the same amount of cash over fewer shares.

But in broad terms the outlook looks better than at any time since privatisation, political factors permitting. Hence the pounds 150m discretionary investment programme announced today. Thames has cleverly spent its cash surplus on improving service quality, rather than customer rebates. The borrowing to pay for this should hit profits by pounds 15m in five years' time.

In the light of yesterday's figures, analysts now expect full year profits to rise from pounds 350m to pounds 362m, which should help the shares firm a little so the yield falls from 7.9 per cent today to more like the sector average of around 7.5 per cent. That high payout ratio reflects worries about Labour's proposed windfall tax, but with gearing of 39 per cent Thames is going to have no trouble paying it. Good value.