The share prices of most of the UK’s big utilities have seen fairly hefty declines over the last 12 months. However, despite the lower prices and higher dividend yields, there are some stocks in the sector that I’m not tempted to invest in. I continue to believe 8% yielder Centrica is a stock to avoid, while fellow energy supplier SSE (8.6% yield) has also joined my ‘avoid’ list, due to its uncertain outlook and concerns I have about its energy trading arm.
However, I’m much more upbeat about the prospects of National Grid (LSE: NG), which is the FTSE 100‘s biggest utility by far, and FTSE 250 water company Pennon (LSE: PNN), which released a trading update today. Their respective dividend yields of 6% and 5.7% may not be as high as those of Centrica and SSE but they’re still very juicy. Moreover, I reckon National Grid and Pennon are better positioned to deliver the steadily increasing dividend payouts I expect from utility stocks.
Income and growth
There were no surprises in Pennon’s trading update for the six months to 30 September and management said it’s on track to meet expectations for the full year. There were no water restrictions for a 22nd consecutive year, with the company adding that its South West Water business continues to score highly on the customer experience survey. Strong delivery during the current five-year regulatory period bodes well for Ofwat’s determination for the upcoming 2020-25 period (due in December next year).
Pennon’s other division — waste business Viridor — is also performing well. It has three new energy recovery facilities in final commissioning as it sees further capacity as essential to meet longer-term demand in what is an attractive growth sector. Today’s trading update hasn’t moved the share price much and with the current high dividend yield and a reasonable price-to-earnings (P/E) multiple of 13.7, I rate the stock a ‘buy’.
Trading on the same P/E as Pennon and with a slightly higher dividend yield, National Grid is another stock I’d be happy to buy a slice of today. Its ownership and operation of vital UK infrastructure assets is an attractively stable monopoly position. In addition, it has geographical diversification and good growth prospects in the US. As such, like Pennon, it looks well positioned to deliver the earnings growth to support steadily increasing dividends in the coming years.
Elephant in the room
Current Labour Party policies directly impact Pennon (“replace our dysfunctional water system with a network of regional publicly-owned water companies”) and National Grid (“ensure that national and regional grid infrastructure is brought into public ownership over time.”)
There’s nothing in law to prevent nationalisation, but there are numerous hurdles and potential hurdles to implementing the policy. The key question for investors is, if the worst came to the worst and nationalisation went ahead, would I be fully compensated? There are a number of laws by which investors could challenge any below-value attempt at expropriation.
The most robust comes through the UK’s bilateral investment treaties (BITs) with foreign countries. These were original designed to protect UK investors from having assets expropriated in developing states without receiving “genuine value” in compensation. However BITs work in both directions. The right of foreign investors in UK utilities to full compensation should collaterally provide protection to British shareholders.