Two FTSE 100 stocks I want to take a closer look at are United Utilities (LSE: UU.) and Severn Trent (LSE: SVT) after trading updates last week.
What they do
Both businesses provide water and sewerage services to specific territories in the UK. United operates in the North West, and Severn Trent operates in the Midlands.
The defensive aspect comes from the fact that everyone requires clean water and sewerage services. This includes personal homes, businesses, and everything in between.
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So how have the shares fared during recent volatility? United shares have been in a pretty steady position over a 12-month period. At this time last year, they were trading for 1,024p and today the shares are trading for 1,033p, a less than 1% rise.
Severn Trent shares have performed a little worse than its counterpart. Over the same period, the shares are down 8%, from 2,768p at this time last year to current levels of 2,527p.
The investment case
For both businesses, the defensive element is of course a plus point as it can help revenues remain stable. However, there are significant challenges to overcome.
Starting with United, its recent update made for good reading, in my view. The business maintained its full-year guidance for the 2023/24 fiscal year, and its earnings growth forecast looks good. A dividend yield of 4.5% at present, and growing moving forward, is promising.
However, it’s worth noting that dividends aren’t guaranteed and forecasts don’t always come to fruition. Furthermore, the firm mentioned inflationary pressures will impact its bottom line, but this was not unexpected.
From a bearish view, debt levels are a risk of note, currently at £8bn. This is higher than the £7bn market cap the firm currently possesses. However, based on future earnings forecasts and defensive operations, I’m not overly worried in the longer term.
Moving to Severn Trent, its update was less clear, providing much less information in regards to future earnings. It did mention the fact it was moving £400m from its next regulatory period (from 2025 to 2030) to the current period. This is being used to invest in infrastructure, namely looking to cut down leaks, sewage spills, and other improvements. This could spell some good news in the future, as it may need to spend less later if it addresses issues now.
From a bearish view, Severn Trent also has debt on its books that could hurt returns and investor sentiment. In addition to this, a recent focus by Parliament on sewage spills – an industry-wide issue, I must add – is something that could hurt investor sentiment too. Finally the shares look expensive on a price-to-earnings ratio of 60!
My verdict
I’m not convinced either of these stocks would be good buys for me and my holdings.
I think there are too many hurdles to overcome that could hurt growth and returns. In my view, there are better FTSE 100 stocks out there for me.
I won’t buy any shares in either stock today, but I’ll keep a close eye on developments.
