Utility Week

Finance & Investment 22 | 1st - 7th August 2014 | utILItY WEEK Market view F or investors, the FTSE-100 is the key yardstick for the UK's leading com- panies. Membership does rotate, but the changes are generally at the lower end of market capitalisation, currently about £3.9 billion. Like the football league, the worst per- formers of the FTSE-100 are relegated to the lower FTSE-250, and the latter's stars are promoted. FTSE-100 membership is reviewed quarterly and usually there are a handful of changes. Of course, for the leading FTSE-100 com- panies, changes at the bottom of the table are hardly noteworthy. Importantly, the UK's top 10 companies are worth more than £700 bil- lion, way above the approximately £40 bil- lion for the least valuable ten at the bottom. Top of the pile is undoubtedly Shell. Its two quoted stocks (A and B shares) are cur- rently worth a combined £150 billion plus. Second up is HSBC, whose operations are predominantly in the Far East, which helped it to avoid the appalling fate that befell RBS that necessitated a £45.5 billion cash injec- tion from the taxpayer. Shell's long-time competitor BP, now recovering from the disastrous Gulf of Mex- ico blow-out in 2010, is currently in third place ahead of Britain's top drugs company, GlaxoSmithKline, with a current capitalisa- tion of £76 billion. The market value of the UK's largest utility, National Grid, is far lower at about £32 billion. Considering National Grid was privatised only as an ašerthought through the percentage holdings of each regional electricity company in 1990, its rise has been quite remarkable. Interestingly, too, given that it has no consumer-facing profile, it has avoided most of the political flak that has enveloped the utility sector in recent months. The same, of course, cannot be said for Centrica ašer the 18-month price freeze pledged by Labour leader Ed Miliband. Nonetheless, despite its recent tribulations, Centrica remains the UK's second most valu- able utility, worth some £16 billion. In fact, this valuation is only slightly above that of Perthshire-based SSE, which is facing a raš of challenges ranging from political issues, such as next year's general election and September's Scottish independ- ence referendum, to outstanding distribution reviews, fluctuating generation prices and uncertainties about renewable subsidies. Of the remaining FTSE-100 utility stocks, both are water companies: Severn Trent and United Utilities. Both are currently valued at less than £6.5 billion and, crucially, still have unfinished business with the ongoing peri- odic review. Severn Trent has yet to agree several capi- tal expenditure issues, some relating to the Elan Valley water supply system, and Ofwat still has to sign off United Utilities' massive sewerage investment programme, which stretches out to March 2020. During a recession, as defensive stocks, utilities would normally be expected to out- perform other sectors, as water has done. However, electricity shares have proved less resilient to the recession, although shares in National Grid – with no significant generation exposure – have been robust since its eight-year UK regulatory settlement. Most stocks in the FTSE-100 are growth- orientated, with the focus being on annual increases in earnings per share and real divi- dend growth. Notable stocks in this category include Vodafone and Rolls-Royce. Both have exten- sive overseas businesses and have grown impressively over the past decade. With varying sector performances, fund managers must be particularly alert when adjusting their holdings to reflect likely trends: their assessments should be focused on the future, not the past. Both the prevailing political and eco- nomic environments are obviously key. In recent weeks, continued instability in the Middle East, and especially in Iraq, has led to an increase in the Brent Crude per bar- rel price, benefiting oil stocks such as Shell and BP. In moving FTSE-100 share prices, there are three leading factors. First, macro- economic issues are very relevant. Aside from political factors, interest rate changes – and the expectation of changes – are crucial. For a highly leveraged company, rising interest rates will push up its financing costs, cutting earnings. In the case of UK housebuilders – Per- simmon is currently the only FTSE-100 rep- resentative – the interest rate impact is even more severe because potential house pur- chasers are also dissuaded from buying. Exchange rate movements, too, are important, especially for major exporters Riding the FTSE rollercoaster There are only five utility stocks in the FTSE-100 but, thanks to political and market uncertainties, they are no longer the boring investments they used to be, says Nigel Hawkins. 1,000 900 800 700 600 500 ftse-100 utilities share prices 25 July 2011-25 July 2014 Sep 2011 Jan 2012 May 2012 Sep 2012 Jan 2013 May 2013 Sep 2013 Jan 2014 May 2014 National Grid Severn Trent United Utilities SSE Centrica

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