Utility Week

UTILITY WEEK | 24TH - 30TH JANUARY 2020 | 21 Finance & Investment Major compromises or a CMA referral are the only effective way out of breaking these deadlocks. It will shortly become clear which companies have chosen the former route and which the latter. The outlook for the water sector may now be far clearer, but the regulated electricity sector still faces real uncertainty. Although it escaped the possibility of being renation- alised, National Grid is facing a very market- sensitive pricing review of most of its UK business, which will have an impact from April 2021. Last May's downward spike in National Grid's share price was mainly the result of Ofgem's proposal to cut the allowed returns for the equity component of its regulated UK operations. It seems certain that, during 2020, National Grid's periodic review will remain the utility sector's biggest game in town – unless widespread merger and acquisition (M&A) activity is undertaken. The eight gas distribution companies are also the subject of periodic reviews on the same timeline as National Grid – which, based on other regulatory reviews, seem likely to squeeze their returns. Investment indicators More generally, there are several issues that affect investment in UK utilities. As has been claimed a‹er previous elec- tions, there is a "wall of money" awaiting investment into the UK. This time round, it might be true. A‹er all, this is the first time for over 22 years that a Conservative administration is in power with a substantial parliamentary majority. Political risk is now quite low – certainly compared with that before 12 December. Of course, the UK must still negotiate an acceptable trading agreement with the EU, assuming that Brexit is indeed delivered at 11pm on 31 January. In fact, with a few exceptions, the main- land EU market is of comparatively little interest to most UK utilities – although it is to many engineering businesses. One of those exceptions is National Grid's expanding electricity and gas interconnectors division; another is ScottishPower, which is owned by Spain's Iberdrola. Although Centrica's overseas focus is pri- marily in the US, it does have a decent gas business in Ireland, where SSE also operates. And, on the electricity front, France's EDF is building Hinkley Point C, and both Eon and RWE have been major UK investors for a generation, although their enthusiasm has waned significantly of late. A relationship with mainland EU countries that fractured further would, though, create significant challenges for the utilities sector. Most potential overseas investors will have noticed that political risk in other lead- ing EU countries is rising. For US investors, who generally try to avoid overt political risk, the UK now looks like a haven of calm. By contrast, in Germany, the CDU/SPD coalition is hanging on by a thread and may disintegrate even before the planned retire- ment of long-serving chancellor Angela Mer- kel. It seems likely that the Green Party will become even more influential. While the latter's participation would undoubtedly boost renewable energy, the risk that some recently built coal-fired power stations without CO2 abatement equipment could be closed down would rise. France, with an elected president firmly in place, should have less volatile politics. Yet deep unrest is identifiable, and leading French utilities such as EDF and Engie are facing serious challenges. In the past few weeks, the formation of a le‹-wing coalition in Spain, including Podemos, has undoubtedly scared many potential investors. The proposal for a single national elec- tricity company could see further upheav- als in a market where structural change has become endemic. And, as always, Italy's politics look unfathomable, and continue to act as a seri- ous deterrent to long-term overseas invest- ment. The shambles of Telecom Italia is an obvious example. Politics aside, UK utilities generally offer good dividends, with some utilities yielding close to 5 per cent – a veritable harvest com- pared with the current derisory yields on UK gilts. Water companies such as Severn Trent will be aiming to offer sustainable dividends until March 2025. Such a scenario may also re-invigorate M&A activity, although the recent rise in ster- ling means that UK utilities are less cheap than previously. Buying stakes in water companies may become more popular as private equity investors analyse the post-PR19 numbers: in the past, Severn Trent, among others, has attracted private equity interest. Centrica, too, must be in the frame. With its share price down by almost two-thirds over the past five years and a dividend cut of 58 per cent, it has not exactly delivered value to its long-suffering shareholders. With the fog of uncertainty li‹ing, UK utilities could be in for an interesting year. Nigel Hawkins, utilities consultant, Hardman and Co RENATIONALISATION The very real threat of renationalisation had hung, like the Sword of Damocles, over much of the quoted utilities sector. BREXIT With a few exceptions, the mainland EU market is of comparatively little interest to most UK utilities. MERGERS AND ACQUISITIONS UK utilities generally offer good dividends, with some utilities yielding close to 5 per cent – a veritable harvest compared with the current derisory yields on UK gilts.

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