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Finance & Investment Analysis Electricity shares and the economy Investor view Daniel Wong What does the upturn in the state of the economy mean for investment in electricity? "The emergence of yield investors forms an important element of allowing utilities to recycle capital once assets have de-risked" W T ith the economy at last picking up, driven by City growth expectations for next year of circa 2.5 per cent, stock market investors will need to reconsider their sector ratings. Should they move more funds into sectors that have been depressed in the past five years – the housing sector springs to mind? In fact, after a disastrous few years, shares in the major housebuilders have rallied strongly, especially those of Barratt Developments and Taylor Wimpey, both of whom entered the recession with excessive debt. Conventionally, electricity investments have been viewed as defensive, albeit with the acceptance that a generation-related business carried more risks than those beholden to price regulation. Recent experiences have decisively disproved this view, most notably within the EU. The share prices of Germany's top two utilities, Eon and RWE, have plummeted, along with those of other major EU players EDF, Enel and Iberdrola. The UK response has been more muted, with National Grid – bereft of any material generation exposure – performing very solidly. In July 2008 its shares were 568p, compared with the current price of 776p. Indeed, its shares reached a peak of 847p last May, shortly after it reassured the market that no dividend cut was necessary following acceptance of the unprecedented eight-year pricing formula for its UK regulated businesses. National Grid is very appealing to long-term infrastructure funds. Centrica's share price performance since 2008 has been similar, supported by its strong domestic gas business. In mid-2008, Centrica's share price was 268p, compared with a current price of just below 350p. While fluctuating gas prices inevitably impinge on its market rating, it has also been adversely affected by Ed Miliband's 20-month price freeze pledge; this would sharply reduce its operating margins and its earnings capacity. By contrast, SSE's share price performance has been lacklustre, despite the payment of robust dividends. Of course, it is far more exposed to generation – clearly reflected in the fact that its share price has barely moved since the 1,377p quotation in July 2008. Weak generation returns have been a key factor, allied to concern about high debt levels and the ability to sustain dividend growth. So other market sectors are more obviously positioned to benefit from an improving economy, such as the retail sector and transport businesses. But it is unlikely that there will be a flood of money away from either the UK electricity sector or from UK utilities generally – it's just that their investment appeal is less compelling. Nigel Hawkins is a director of Nigel Hawkins Associates, which undertakes investment and policy research he emergence of listed, yield-focused vehicles, or YieldCos, as long-term owners of renewable energy assets has been one of the key themes of the listed market in 2013. It is a welcome additional source of capital for the sector, particularly for utilities seeking to scale back balance sheet commitments. With ten-year gilts yielding 2.7 per cent and the market average yield on UK shares around 3.8 per cent, businesses promising stable yields of 6-7 per cent have been attractive to the market. Over the course of 2013, listings have included Greencoat UK Wind, Renewable Infrastructure Group, Bluefield Solar, Foresight Solar and Infinis. Together they have raised over £1 billion of capital in a sector that had been out of favour since 2007/08, when many larger developers failed to deliver optimistic Many utilities development pipelines. are now The trend seeking to is not limited scale back to the listed their balance market. Pension fund and insursheet commitments ance investors, such as Hermes, MEAG and Allianz, which have long recognised the benefit of investing in stable yielding assets, have also been active in buying renewable energy assets across western Europe. Utilities in Europe accounted for about 10 per cent of global investment in wind and solar farms in the past five years. However, many are now seeking to scale back balance sheet commitments. This trend is expected to deliver a steady stream of assets to market, and the emergence of yield investors helps utilities to recycle capital once assets have de-risked. With the large influx of issuances coming to market against a backdrop of forecast interest rate rises and regulatory uncertainty, many question the long-term sustainability of the listed renewable YieldCos. However, Foresight and Infinis have recently closed their books successfully and there is list of new names queuing up to list in the next few months. Observing the more established listed PFI fund market suggests the desire for stable yields will remain strong throughout the cycle. Provided interest rates stay low, we think listed renewable YieldCos are here to stay. Daniel Wong, head of power & utilities, infrastructure and real estate, Macquarie Capital Europe UTILITY WEEK | 29th November - 5th December 2013 | 19