Thursday, 16 May 2013

Severn Trent and the Utilities "sweet spot".

Severn Trent @ 2062p, -28p (-1.34%)
Pennon @ 697p, +1p (+0.14%)
United Utilities @ 761.5p, -1p (-0.13%)
National Grid @ 835p, -9.5p (-1.12%)
Centrica @ 386.5p, +0.6p (+0.16%)
SSE @ 1593p, +2p (+0.13%)

Well Utilities seem to be in a little sweet spot at the moment if valuations are anything to go by. 
Severn Trent being the latest utility to come under an acquisitive eye from an overseas consortium of investment and pension funds.
The recent rise on the initial announcement has put Severn Trent on 23 times next years earnings, and a forward yield of 4.2%, which, to me at least, seems a very hefty price valuation for a utility.
The argument for a pensions fund is the premium attached to a secure regulated earnings stream for years to come, but for a private investor, such as myself it, seems far too expensive and, unless actually taken over, certain of a fall as other cyclical industries come back to the fore in a recovering economy.

The nature of regulated industries is that they are highly geared in debt to squeeze every penny of profit from the perceived secure cash flows so there would be little there to make the business case more attractive for me at these levels either.
But it is interesting to see how different investor requirements justify different valuations and the premiums that they may be willing to pay for suitable investments.

The Severn Trent board have subsequently rejected the potential bid as too low though ( Severn Trent rejects £5bn takeover bid by consortium including Kuwait).

Of the remaining UK water utilities: Pennon is on a forecast 16.7 times and 4.3% yield, and United Utilities is on a forecast 19 times and 4.6% yield.

Elsewhere, Portfolio holding National Grid is at the top end of a more normal trading valuation for utilities (in my view anyway), at 15.1 times next years earnings, and a yield of 5.1%,  as the results were published today with a strong "inline with managed expectations" message and a forward forecast of predictability with much of the company's business, and capital plans, regulated and agreed.

Centrica is on a forecast price to earnings of 13.9 and a forecast yield of 4.6%, whilst SSE is on a forecast 14 times and 5.4% yield.

So despite being in the spotlight and having momentum behind them I would be very wary of overpaying for utilities in the current time given the willingness of others with different criteria and deeper pockets.
As mentioned earlier, my view is that the more secure, but lower earnings prospects of utility companies will see them cycle down as other sectors more geared to economic recovery come back into the spotlight and that would be a better time to invest for an investor with my resources and investment horizons.
But this view aside, the recently announced change in leadership at SSE might be the reason that this company's valuation and yield seems more reasonable than the rest.
However, I still think that the sectors valuations will cycle down and present a better value entry point for the patient investor.

Related article links: Severn Trent rejects £5bn takeover bid by consortium including Kuwait Investor Relations

Related post links:
April 2013: Portfolio Update.

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