The European utility sector is consolidating as a result of market liberalisation, according to Suza...
The European utility sector is consolidating as a result of market liberalisation, according to Suzanne Ferlic, manager, European credit research at Schroders.
Ferlic says increased competition in home markets and business diversification through M&A activity is leading to long-term deterioration in credit quality for companies in the European utility sector.
'M&A activity continues to be a focus of the large, highly rated incumbents as they expand to other countries in response to the opening of their home markets,' she says. 'This expansion has been the catalyst for the decline of the average rating of the European utility sector from AA to single A, with continued negative rating migration expected in the longer term.'
Since January 2002, Ferlic says Standard & Poor's and Moody's have taken a total of 70 ratings actions in the sector, three-quarters of which have been negative, including 22 downgrades.
Among the larger European incumbents, Ferlic says there has recently been a slightly more conservative outlook as companies seek to integrate recent acquisitions, avoid further weakening of balance sheets and rationalise growth strategies.
She says companies that look capable of eventually dominating the playing field need to preserve balance sheet integrity and strategic resources until cross-border activities develop enough to create a robust pan-European market.
Robert Machell, head of pan-European equities at JP Morgan Fleming Asset Management, says the group is marginally overweight in the European utility sector at present.
Compared with other defensive sectors in Europe, he says the sector represents reasonable value and utilities are a good, stable area of the market. He says: 'I like the true utilities, not those companies that are trying to grow, but rather those that are providing a steady cashflow.'
Examples of companies Machell likes include the UK companies United Utilities and Severn Trent, which both look cheap and stable. He adds they will not do anything exciting, but it is for this precise reason he wants to hold them.
Machell also likes the German company E.ON, which he says is a classic utility with a restructuring twist.
It is divesting its non-core holdings and is also trying to acquire the German gas company Ruhrgas in order to create a premier position in gas and electricity in Germany, says Ferlic.
Over one year to 31 October 2002, the DJ Euro Stoxx Utility Price Index has outperformed the DJ Euro Stoxx Price Index by 3.21%, returning -26.68% compared with the index, which returned -29.89%. The sector has underperformed the index over the past three months as a result of the recent rally in markets from 9 October.
Indeed over three months to 31 October the sector underperformed the index by 1.46%, falling -7.06%, compared with the index, which returned -5.60%.
Machell says: 'Something to watch for in the sector is the number of government placings of non-listed holdings. A concern over the next 18 months is the number of primary and secondary issues in the sector driven by the European Stability Pact. Companies with an exposure to Latin America are also a concern.'
Sector is in process of consolidation.
Sector outperforming the index over the year.
Sector represents good value.
Rally has led to sector underperformance.
M&A is leading to decline in credit quality.
Latin American exposure is a concern.
To ensure creditworthiness assessments compliant
Avoid broad-brush strokes
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