Utility Week - authoritative, impartial and essential reading for senior people within utilities, regulators and government
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18 | 13TH - 19TH FEBRUARY 2015 | UTILITY WEEK Finance & Investment Analysis I nvestors, whether fund managers or pri- vate clients, generally seek either capital growth or dividends from their invest- ments, or a combination of the two. For the UK, investors seeking capital growth will have found the going hard, espe- cially since the FTSE-100 peaked at 6,930 in December 1999. By contrast, property inves- tors in hot spots, such as London, enjoyed substantial growth if they held such assets since December 1999. Furthermore, with the financial crisis having an impact from 2008 onwards, many major companies have found consistent growth elusive. Hence, the search for decent dividends has become a priority. In recent weeks, three widely reported events, all with dividend-paying implica- tions, merit comment. First, confirmation that a €1.1 trillion (£0.8 trillion) European quantitative easing programme will be launched in March has driven down bond yields even further. The yield on a 10-year German bond is now around 0.4 per cent, which is hardly an incentive to invest. The UK equivalent is 1.5 per cent, unexciting though this may be. Second, over the next few weeks, sev- eral leading companies will present their full-year results. While the bank reporting season in mid-February used to be crucial, its importance has waned aer the near col- lapse of RBS and Lloyds. Oil heavyweights Shell and BP have just announced their 2014 figures. Historically, both have been substantial dividend payers and therefore key components of pension fund returns. Shell, which has not cut its div- idend since 1945, confirmed that its current dividend base would be retained. Despite its many challenges, BP has done likewise. Of course, if the weak oil price persists for a prolonged period, this might well change. Third, on the retail front, many pension- ers have aggressively joined the quest for competitive financial returns. The shambolic administration of the sale of National Sav- ings' 65+ guaranteed growth bonds has been widely reported. That they are offering a 4 per cent annual return if held for three years – a generous and presumably election-related return – means they are highly attractive to retired people seeking assured income, assuming they can place their buying order. Against this background, where can investors seek out decent dividends? Aer all, many fund managers require a long-run- ning – and secure – stream of dividends to fund their long-term liabilities. Historically, they have used a mixture of gilts and equities to provide such returns. With gilts currently offering minimal returns, despite the epic levels of public borrowing, equity yields look comparably attractive – providing investors can avoid stocks where a dividend cut is likely. A disproportionately high yield is generally a reliable signal. When the utility companies were priva- tised, the payment of a good dividend was seen as paramount. Pennon's predecessor, South West Water, was floated in 1989 on a yield of 8.61 per cent, a yield that was driven upwards by the tainting of the Camelford pollution incident. Traditionally, utilities have been regarded as low-risk, defensive investments, with a solid dividend profile. Within the UK sector, it is no longer so clear-cut. Many of the origi- nal privatised utilities have been absorbed into larger companies or been taken into pri- vate equity ownership – but several remain. In the water sector, there are two FTSE- 100 water companies: Severn Trent and United Utilities, both of which are in the final throes of the long-running 2014/15 periodic review. Both companies have now accepted Ofwat's final determination. While United Utilities is not cutting its dividend, Severn Trent is trimming its divi- dend base by 5 per cent. The latter has effec- tively accepted the case for a re-basing now to enable higher future growth – a payout scenario that may confront the new manage- ment of troubled Tesco. In Severn Trent's case, corporate activity is widely anticipated, with its share price still below the widely-reported £22 per share offer that was controversially spurned in mid-2013. For many long-term investors, includ- ing several overseas funds, National Grid remains highly attractive. It is currently capi- talised at c£35 billion. Importantly, its core UK business's returns are underpinned by a price regulation settlement that expires in 2023 and, unlike most UK utilities, its politi- cal exposure is low. As such, many fund managers compare its prospective yield of around 4.6 per cent with that of the UK 10-year gilt yield of c1.5 per cent. The 310 basis point gap is pivotal for many discerning investors. SSE, also a FTSE-100 stock, contin- ues to face many challenges, despite the outcome of last September's inde- pendence referendum. It currently yields a prospective 5.6 per cent, but there are many risks, ranging from depressed generation returns to politically-driven mar- gin cuts – and even an independence refer- endum re-run. The outlook for Centrica is even cloud- ier. It is due to report its 2014 full-year fig- ures shortly, with a new chief executive, Iain Conn, in place. There is a real chance, given the manifest uncertainty on several fronts, that Centrica's dividend may well be re-based, perhaps as part of a wide-ranging "kitchen-sinking" exercise from Conn. In recent years, Centrica's yield has risen as concerns about its long-term dividend- paying capability deepen. Given its overt exposure to political developments over the next few months, share price volatility seems inevitable: a cut dividend would be a further unsettling factor. Whilst utility press comment will focus heavily on political issues in coming months, utility fund managers will continue the quest for dividend growth. Nigel Hawkins, director, Nigel Hawkins Associates Chasing yield and dividends Against the backdrop of a new quantitative easing regime in the EU and in the midst of full-year results from some giants of industry, Nigel Hawkins explains what's driving investor interest. "Traditionally, utilities have been regarded as low-risk, defensive investments, but now it is not so clear-cut."