Investment Column: Hyder waters down tax burden

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Some things in life are just not fair, as Graham Hawker, chief executive of Hyder, found to his cost in last week's Budget. His watered- down reaction for public consumption, that the tax was "particularly harsh", was echoed by most City analysts. The pounds 282m bill, made up of pounds 192m for Welsh Water and pounds 90m for Swalec, amounted to 24 per cent of Hyder's market value. Compare this with Anglian, which will pay a levy worth 11 per cent, or British Telecom, which "escaped" with a tax of only 1.7 per cent.

Hyder's decision to launch a "fundamental review" of its finances unsettled the share price just when shareholders in every other privatised utility saw the value of their investments surge. Yesterday Hyder's shares ended 21.5p higher at 827.5p as investors breathed a well-earned sigh of relief at the company's announcement that it was "confident" it could continue to deliver "satisfactory" dividend growth. Despite the scale of the burden, Hyder plans to change precisely nothing.

The group has no plans to cut spending. The tax, payable through increased borrowings in two tranches by December 1998, will raise Hyder's annual interest bill by pounds 20m. One possibility was to reduce the discretionary investment programme on environmental improvements, worth pounds 30m plus annually. But this is too difficult, politically and practically, to contemplate. The same could be said for the second option, to cancel the pounds 11m of annual cuts in bills to customers agreed with Ofwat under its voluntary "abatement" programme.

The reason for Mr Hawker's confidence says much about the continued strong prospects for profits and dividend growth across the water sector. Though Hyder's gearing will rise from 100 to 200 per cent, it should still manage a dividend increase for the current financial year of 11 per cent in money terms, compared with the 14 per cent forecast by analysts before the windfall tax. With a prospective yield of 7.5 per cent, it suggests plenty of prospects for capital growth. As the table shows, some of the healthiest companies will manage dividend increases of up to 14 per cent. The real crunch will come, not with the windfall tax, but in 2000 when the regulator is expected to make substantial price cuts to bring down dividend growth.

The current price formula, which allows real term increases in bills to fund investment spending, leaves plenty of room for water companies to raise gearing to pay the windfall levy. And given generally high dividend cover in the sector, investors will continue to enjoy pacy dividend growth. Hyder certainly looks undervalued, at least until 2000. Investors should buy.