LON:CNA | Utilities - Time To Sell??

13th Feb '17 by tscott

2 comments 7732 reads

Utilities have been fantastic investments over the last 5 years with investors not only rewarded with strong share price performance but also healthy dividend yields. The exception is Centrica which warned on profits and was forced to cut its dividend but it too has recently been showing signs of recovery with a positive trading statement in December 2016. Is now the time to sell or trim holdings in the sector?

Over the last 12 months most utility share prices have flatlined which means they have been underperforming a rising market by around 15-20%. Here are some of the pros and cons:

Pros
- an attractive yield premium to the market even after the rise in share prices over the last several years.

- most pledge to raise their dividend at least in line with inflation which is important as inflation is beginning to accelerate

- the yield premium to most other assets is even better. Government saving products like premium bonds,bank account interest rates, cash Isas etc have all been reducing rates of return recently despite rising inflation. Gilt yields have risen slight but are still very low from both a historic point of view and vs. utility dividend yields.

- the sector is a safe haven and one of the few genuinely defensive areas of the market. It was noticeable that the relative high for the sector last year was just after Brexit, the moment of maximum uncertainty. If you think there is going to be a UK recession or there could be an economic or political catastrophe (e.g. Greece not getting its money from the latest bailout) then utilities will do relatively well but will still fall in a bear market.

- the sector continues to consolidate and there will almost certainly be further bids in the future. Last year Dee Valley was taken over by Severn Trent despite a failed protest by local shareholders taking the takeover to a tribunal. The premium was reasonable as it was a contested bid but Dee was already a rewarding investment ahead of the takeover with a decent yield. Pennon might be the next in play with water stocks more likely to be taken over than electricity stocks.

Cons
- Like a lot of other defensive sectors (e.g. tobacco, consumer staples) the sector…

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Julian Rowe

23rd Nov '17

Centrica - 13-Feb-17 at the time of this post was at a stock price of 235.80. The theme of the post was: Utilities - time to sell??

At the time of writing this message The 23 Nov 17 with a rev of over 28bn, EV=over 13bn GBP CNA has fallen over 15% today alone, to eod stock price 138.1

Centrica CNA 138.1p -25.2 -15.4% 4:25pm 10.00k
SR STYLE: Balanced, Large Cap, Contrarian.

Personally, my holding has now lost 60% of its value from 8.3k GBP (l loss of almost 5k). I must have been dreaming or asleep. I don't allow other stocks to do so badly....

In hindsight, the timing and sentiment of the original post was absolutely "on the numbers".

My view is the management is good, and the turnaround plan seems sound. Losing 800k customers in 4 months is worrying, but 500k + was the result of these 'mass moves' (group purchasing), and presumably can be replaced in similar order if the deal is right.

tscott

The problem for utilities and Centrica in particular is that they are facing a perfect storm which appears to be gathering pace. The main reason why so many private investors hold utilities is for the yield but for many of them the dividend now appears under threat. Centrica is definetly discounting a cut in the dividend, despite what the management said today, as it now yields over 8%. Generally, a yield of over 6% suggests the dividend is no longer safe and SSE is also considered to be unsafe in this regard. The water shares have also fallen sharply recently. UU and SVT both had decent sets of results in the last 2days and increased their dividend payouts but the shares have been under a cloud for some time as political risk has escalated.

Political risk has risen as the Government has championed the consumer making it easier for consumers to switch supplier. This is why Centrica lost so many customers since June. However, there is also regulatory risk with reviews for both water and electricity likely to make it harder for companies to achieve a decent return on capital. More recently, political risk has risen on the realisation that a Labour government could be elected with Corbin as PM and Labour has pledged to renationalise several privatised companies. The water sector is seen as especially vulnerable in this regard and has contributed to the recent sell off but other sectors like rail and bus franchise stocks have also fallen on renationalisation fears.

A final factor that has recently contributed to the weakness of utilities has been rising inflation and interest rate expectations. Many utilities have significant debt and if rates rise it will affect profitability. A broker turned bearish on UU partly because much of its debt is indexed to inflation which has risen to 3% recently. With the interest rate cycle having turned utilities have lost some of their attraction as a bond proxy meaning those quoted companies with higher than average yields will be less attractive as the interest rate paid on cash and bonds rises.

I am still holding onto my utility shares which are NGT, SSE, SVT and UU as I hold them for the yield and see the dividend as safe for the time being, even in SSE where the household utility billing is a much smaller part of their business. Also, SSE has proposed merging that part of the business with N Power as it has become uneconomic in the current political and regulatory environment. For Centrica the situation is likely to get worse which is why the market was so harsh on the shares today. It appears only a matter of time before the company cuts the dividend as it will lose more customers and is changing its SV Tariiff. If the management refuse to acknowledge that it is in the interests of shareholders and other stakeholders to cut the dividend the shares could drift further but often the time to buy is when the company does bite the bullet as the uncertainty is removed and the market hates uncertainty.

One positive note is that things have got so bad for the utilities and especially electricity companies is that the political risk from the incumbent government and regulators may recede. There is an article in today's Times to that effect. There is no point in hitting companies so hard that they cannot provide a decent service or generate a reasonable return on capital.

Utilities - time to sell??

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Tscott

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