Utilities have performed well in recent months, after lagging over the past few years, says Raj Shan...
Utilities have performed well in recent months, after lagging over the past few years, says Raj Shant, head of continental equities at Credit Suisse Asset Management.
According to the FTSE World Series Index for the year to date, utilities stocks in Europe have outperformed general European stocks by 20% in local currency terms. Despite this, fears about the effects of deregulation have put off many investors from buying into these companies.
Instead of proving investors right, the companies in the utilities sector have coped well with the issues surrounding deregulation and many have benefited from opportunities opened up to them.
Shant is now overweight utilities, seeing those that have offloaded subsidiary companies not core to their business while increasing focus on activities where they can rely on decent margins as attractive investments.
Shant gives the example of E.ON in Germany, noting the company, the result of a merger between Veba and Viag, has responded well to deregulation.
The firm has managed to fund growth in the power market through the sale of its telecom arm Viag Telekom to BT and by swapping Veba Oel with BP for Ruhrgas, Shant explains.
He says: 'These were smart moves because E.ON managed to offload the telecoms business at a full price before it had to bid for expensive third generation (3G) licences and it managed to build up the core business at the same time. The swap of petrol outlets for a power company means the company has concentrated its expertise in power distribution where there are higher returns.'
The expansion further into the power sector has also continued with the company's purchase of PowerGen, which has exposure in the US as well as the UK.
But expansion into other markets is not always two-way traffic. The French power market continues to be State-run, but it is keen to buy outside France, according to Mark Denham, director of European equities at Clerical Medical.
This has been a bone of contention, he says, as foreign companies cannot buy into French stocks. This has led to the Italian and Spanish governments to ban purchases of private companies by State-owned concerns. The French national power company EdF managed to overcome this by teaming up with the family-owned car conglomerate Fiat to buy the Italian power company Montedison.
Julian Sinclair, investment manager for the Gartmore Global Utilities fund, says: 'EdF management will need to make it clear how they are going to finance their purchases and will need to be careful where they are moving into less regulated markets.'
Denham holds stocks of the Spanish power company Union Fenosa, as he sees it as a potential target of other European utilities that are looking to consolidate. It has not been bought yet as it has been seen as too expensive, although Denham thinks that the sector as a whole is highly priced so that such consolidation will always be carried out with 'behind closed door deals.' On the negative side, Sinclair points out that the sector is highly valued and says that as a defensive area, it may see a fall in investment when sentiment in the economy improves.
• Consolidation good for growth.
• Deregulation driving firms' profitability.
• Cost cutting in light of deregulation.
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