Companies in the news: the water utilities

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Water companies used to be reliable investments. Since they were privatised in 1989 they have cut costs and paid dividends to shareholders. But in recent years they have been squeezed by water regulator Ofwat.

Low bills for customers seem to be more important than dividends for shareholders, even though water firms need to attract investors to finance their businesses and protect their lenders from bearing too much risk.

Last week, Ofwat showed it was prepared to squeeze profits even harder. It reckons low interest rates mean that water firms can finance themselves more cheaply than before and so don't have to charge customers as much. Ofwat thinksthese companies can keep lenders and shareholders happy by earning returns of just 3.85% (before inflation) on their pipes and reservoirs.

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Many in the City are not so sure. At the last review of water prices in 2010, both Severn Trent and United Utilities had to cut their dividends.

Pennon avoided doing so because it had a thriving unregulated waste business, but it doesn't now. With water bill increases to be kept below inflation, and profits being squeezed, investing in these stocks looks a lot less attractive.

More dividend cuts can't be ruled out. Income seekers may want to switch into National Grid (LSE: NG). The company knows the prices it can charge until 2021 and has promised dividend growth in line with inflation until then.