Should Investors Sell Centrica PLC, Avoid United Utilities Group plc & Hold Severn Trent plc?

A bond-like investment?

Boring?

Hot property, rather.

But if you think utilities are a safe investment right now, well, think again. 

Landscape

Centrica (LSE: CNA) reported disappointing interim results on Thursday. Unless management announce additional stock buybacks, shares in the owner of British Gas will continue to underperform both the broader market and the utility sector. It’s not a bet worth taking right now, in my view. 

Severn Trent (LSE: SVT) is a more valuable business, whose shares have done well in recent months. It’s investable (just), although leverage ratios are pretty high. I would include Severn Trent stock as part of a diversified portfolio. It’s not that I like it, though. 

Meanwhile, yield-starved investors are taking big risks betting on United Utilities (LSE: UU). A takeover is just around the corner, according to the rumor mill. That’s not the most obvious outcome, in my view. 

Centrica Is Not Worth Your Money

“The group has now completed its £420m share repurchase programme (…) in line with our stated policy, we expect to deliver real dividend growth this year,” Centrica said on Thursday, when it reported downbeat quarterly results. Earnings and cash flows are under pressure. I think Centrica’s market-beating dividend yield is not safe. Centrica, as I have recently argued, is also struggling to manage its short-term liquidity needs. 

The company is faced with several problems. The average residential gas consumption for the first ten months of 2014 “was 21% lower than for the same period last year, with average electricity consumption 7% lower,” it said on Thursday.

It’s not that buybacks are the answer to value creation at Centrica, but they have provided support to the shares in recent months. What’s going to happen now that buybacks have ended is anybody’s guess. In spite of a dismal stock performance this year, downside is still 15% or more, in my view.

There are better options out there. Is that right? 

A 25%-plus Upside For Water Utilities?

Water regulator Ofwat sets limits on charges for water and wastewater services every five years. Its final determinations now are expected to be published on 12 December, and will have an impact on investment plans of water companies as well as on the valuations of their shares. 

The widespread view is that infrastructure funds, which already control about half of the regulated water assets in the UK, will take control of United Utilities and Severn Trent. Both companies have high debts and their financials are not reassuring, but it’s likely they will attract bids, stock brokers insist. 

United Utilities, in particular, has drawn the attention of many brokers in the last few days. Its stock has risen by 36% this year, and looks fully valued. Ontario Teachers and funds from the Middle East are rumored (again!) to be considering a bid in the region of 1,200p, for an implied 32% premium from current levels.

Severn Trent, for its part, may be targeted by infrastructure funds, which may offer a 25% premium to its current market value. Severn Trent isn’t cheap, but is cheaper than United Utilities. That’s the main reason why I’d retain some exposure.