This report is not a personal recommendation and does not take into account your personal circumstances or appetite for risk.
UK Index Utilities remains a sector under extreme pressure, down another 1% this morning and underperforming the wider market, failing to display the defensive attributes that would normally have one rushing to their safe revenue, profit and dividend streams. Especially during a market volatility storm such as that which we were handed this week. As much as the likes of United Utilities, National Grid, Severn Trent, Centrica, SSE et al. are supposedly non-cyclical ports in a storm, a raft of headwinds continue to strengthen since share prices peaked mid-last year.
Firstly, regulatory issues include proposed energy caps by OFGEM which may be written into UK law sooner than feared, potentially in place by Christmas. An upcoming review from OFWAT. Both could impact business models, denting cash flows and risking the sustainability of attractive dividend policies, sapping interest from income seeking investors.
Secondly, political uncertainty plays a part. Not so much in terms of Brexit, rather that the potential for a Labour win in 2022 (or earlier) risks Corbyn following through on a pledge to take the Water sector public again. This removes any of the M&A attraction that the sector offered in years gone by.
Thirdly, we’ve been getting used to tightening monetary policy in the US for a year now, and global bond yields back up around multi-year highs means borrowing is already more expensive. A hawkish statement from the Bank of England yesterday, however, only goes to highlight that the days of extremely low global interest rates – a boon for long-term, heavily capital intensive sectors like utilities – are numbered, making business more expensive. This may signal the end to the sector being a viable alternative to bonds whose yields were depressed by the QE bond-buying stimulus of recent years.
As it stands, income seekers have two choices. Risk further capital depreciation in return for a potentially unsustainable 5% dividend. Or go with Uncle Sam who’s finally offering a safe near-3% again.
Mike van Dulken, Head of Research, 9 Feb 2018
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