Will BG Group PLC Outperform Utilities?

With the stock market trading around all-time highs, investors in the UK may consider more defensive stocks to protect their returns. How about utilities?

BG: No Sacred Cows

“BG Group has been transformed from an offshoot of a former nationalised utility into an international energy business focused on exploration and production and LNG,” BG Group (LSE: BG) (NASDAQOTH: BRGGY.US) says. Its valuation doesn’t reflect that.

BG shares have underperformed those of most utilities this year, with the exception of Centrica. BG is not the most obvious investment proposition, yet this gas and oil producer is a restructuring play that may yield dividends. 

• “Andrew Gould, BG’s chairman, told the burly 58-year-old that the board had decided to fire him. Stunned, Mr Finlayson said in that case he would quit,” the Financial Times reported in early May. The board ousted Mr Finlayson — “the burly 58-year-old” — after about a year in the job.

• “There are absolutely no sacred cows in the portfolio as we will look at everything,” Mr Gould argued last month.

If a truly radical restructuring takes place, and BG properly manages expectations for production growth, its shares could outperform the sluggish utilities sector over the medium term. Proceeds from divestments could also boost its share buyback programme. In its current form BG is too big to be acquired, unless a consortium launched a bid with the intention to separate LNG assets from BG’s upstream operations. 

Elsewhere, it was announced Sunday that BG had agreed a $30bn gas supply deal in Egypt with the partners of Israel’s Leviathan, which testifies to strong political and commercial ties with key investors. 

National Grid

National Grid (LSE: NG) (NYSE: NGG.US) boats a dominant position in the marketplace. Although estimates for revenue and earnings growth aren’t exciting, it remains a cash machine with a solid dividend yield of 5%. The regulatory environment is tough, capital expenditure plans are demanding, and net leverage is high, but I would expect it to outperform smaller utilities, particularly if stock market volatility springs back.

In 2014, its shares have lagged behind those of Severn Trent (LSE: SVT), SSE and United Utilities by 7, 10 and 25 percentage points, respectively. Expect the performance gap between these three and National Grid to shrink as National Grid shares appreciate faster. National Grid has outperformed the broader market this year;  its dividend policy and expansion plans in the US may surprise on the upside.

Severn Trent & Centrica

The cash flow of Severn Trent is deteriorating fast, and the company has little room to raise new debt because is highly leveraged. In fact, if it decided to raise more debt either in the form of bonds or loans, the value of its outstanding debt obligations, which are traded in the secondary markets, would come under strain. That is not something Severn Trent can afford right now. Its gross cash position, which stood at £123m as of 31 March 2014, is the lowest in about a decade.

I am not upbeat about its dividend policy, either. And I believe that only a fully fledged takeover would yield significant upside to investors. Severn Trent may soon be in trouble, unless its banks are willing to provide a helping hand. Water is a good business to be in, but big differences still exist between the utilities’ pricing and spending plans and what Ofwat believes is appropriate, my Foolish colleague Roland Head argued earlier this month. Its equity value is down 1.3% since I discussed its prospects on May 29.

Centrica — the worst performer of all utilities I have looked at — is also an investment I’d avoid. Since I wrote about it on May 16, its stock is down 4.8%, but downside risk is much greater than that to the end of 2014. As opposed to National Grid, the dividend payment hasn’t contributed to the drop, for April 23 was the ex-dividend date for Centrica.