Utility companies are still relatively cheap even though share prices have been boosted by the marke...
Utility companies are still relatively cheap even though share prices have been boosted by the market switch from technology, media and telecom stocks.
The average P/E ratio on a FTSE All Share company is 25 times, while gas and water companies have average P/Es of 20.95 and 7.28 respectively. Between the end of March and the beginning of June the total return on the FTSE Gas Distributors index was 9.83%, in contrast the FTSE All Share fell by 4.6%. While the share prices of utilities may have risen they have maintained their above market average yields. The All Share currently yields 2.85%, 400 basis points lower than the average water company yield. Britannic Asset Management believes the rally in utility shares has not finished. The group is overweight the sector and intends to maintain that position. Ralph Brook-Fox, fund manager at Britannic, says: "Dividends offered by utilities are priced off bonds. Bond yields seem to be falling so demand for utilities should pick up. We are also close to the peak of the interest rate cycle, which makes equities attractive."
Brook-Fox is overweight all three sectors: water, electricity and gas. With water the primary reason is the current cheap valuations of companies. His favoured holdings are Kelda, Anglian and Severn Trent. Within the electricity sector his favourite holding is Scottish & Southern. The company has a strong management and cost savings from its merger with Scottish Hydro will be greater than the market expects, according to Brook-Fox. In addition he says the company's strong balance sheet should bode well if there is any M&A activity in the sector. Brook-Fox likes both Centrica and British Gas. Chris White, the manager of LeggMason Investors UK Income unit trust, believes the combination of Transco and British Gas International is undervalued and restructuring should have a significant impact in enhancing shareholder value. British Gas later this year intends to split its BG International oil and gas exploration unit from its Transco pipeline arm. Transco, the UK's sole natural gas distributor, wants to use its 2,500km pipeline network for telecoms, leaving British Gas to focus on its exploration unit where natural gas and crude oil output are rising.
Although White is overweight British Gas, as a whole he is underweight utilities. He views the sector as highly regulated with company profits being capped. White's main underweight position is among electricity distributors. He says: "My big concern is the fall in the electricity pool price. The increased competition from US and European entrants bringing downward pricing pressure."
Within the sector regulatory problems seem to be out of the way and the downside risk seems to be limited compared to the rest of the market, according to White. He adds: "On the upside corporate activity is increasing. There has been a take-over attempt for Hyder from Momura and also a counter-bid by US group Western Power Distribution."
His favoured water companies include Pennon and Severn Trent. Pennon offers a yield of 8.7% while Severn Trent's is 7.7%.
‘Most significant’ upgrade since launch
Changes happening over coming months
Had accepted British Steel business
Aimed at HNW clients and family groups
Set for 1 April 2019