Interactive Investor

Utilities: A sector to outperform in 2020

A City analyst has just upgraded its view on a swathe of utility stocks. Here are the names to watch.

19th December 2019 14:27

Graeme Evans from interactive investor

A City analyst has just upgraded its view on a swathe of utility stocks. Here are the names to watch.

Defensive energy and utility stocks continue to make waves after a City bank today upgraded its view on companies including National Grid (LSE:NG.), Pennon (LSE:PNN), Severn Trent (LSE:SVT), United Utilities (LSE:UU.) and SSE (LSE:SSE).

The note on European utilities by Deutsche Bank comes as the dust finally settles on an uncharacteristically tumultuous year for the sector, with UK players spooked by the threat of Labour nationalisation.

Now that an emphatic Conservative majority has put these fears to bed, Deutsche highlighted the consequences of a significant de-risking of stocks across the power and water industries. 

For National Grid, South West Water owner Pennon and SSE, this has meant an increase in Deutsche's price targets of 5%, 6% and 8% to 980p, 1,080p and 1,400p respectively.

Severn Trent and United Utilities have been upgraded by a more modest 4% and 3%, which reflects the impact of Ofwat's recent final determination on the prices that water companies can charge customers over the next five years.

The regulator has described its plans as the starting point for a transformation of the water industry, including a major investment programme to deliver improved services. At the same time, customer bills must fall by an average of £50 before inflation.

The upshot according to Deutsche is that Severn and United will see lower-than-expected price cuts in the early years of the 2020-25 regulatory period, with greater price cuts later on.

Power network company SSE is also facing a regulatory squeeze after Ofgem signalled its intention to reduce the returns that investors can expect from the electricity network.

The price control period from 2023 will also seek to drive companies to go further to decarbonise power generation and achieve a net zero emissions economy.

Overall, however, Deutsche Bank said the backdrop for the European utilities remained positive, with the sector on track to outperform again this year.

Although it is now the best performing sector over the past three years, the note said valuation multiples still lagged the potential increase that could be justified by a drop in bond yields.

Deutsche added:

“Our high level sector framework suggests that there is more to come, given low bond yields and robust medium-term earnings growth.”

With companies like United Utilities offering a dividend yield of 4.4%, the continued attraction for investors in an era of ultra-low interest rates is obvious. Demand for water changes little no matter what the economic backdrop, with reliable customer income leading to dependable dividends. 

The possibility of a Labour government bringing utility companies back under state control – and at an unknown price – had threatened to scupper this income source.

The relief of investors in the two days after the election was shown in Pennon rising 14.5%,  with Severn Trent 12% higher and United Utilities up 11.5%. Severn and United are now trading at two-year highs, with Pennon at an all-time high amid speculation that it may decide to split its Viridor waste management business.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

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Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

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