Sector in Focus: Utilities

Reliable dividend payers can be found in a wide variety of sectors, but utilities providers are often considered a good place to start your search

Morningstar.co.uk Editors 10 September, 2013 | 7:00AM
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Reliable dividend payers can be found in a wide variety of sectors. One such sector is that of utilities companies, the nature of which has led to a reputation for returning profits to shareholders on a regular and steady basis. Let's take a close look at this sector and some of its key players.

Utilities companies are typically local monopolies that own transmission and distribution networks that deliver electricity, natural gas, water or other energy sources to customers in a given service territory.

In most developed countries, industry regulators typically set the rates at which providers can charge customer for utilities. This ensures that investors in utilities companies recover a fair return on capital while ensuring the utilities businesses keep their systems well maintained.

Regulated distribution utilities are among the most defensive investments available, with solid cash flow, high dividend pay-out ratios and low cyclicality. Morningstar utilities analysts typically expect total annual equity returns near 10% for regulated utilities through all economic cycles. 

Diversified utilities tend to be holding companies with businesses that could include traditional regulated T&D (transmission and distribution) operations, wholesale power generation, retail supply or infrastructure. They are still defensive investments but carry more risk than their fully regulated peers.

Independent power producers, although officially within the utilities sector, are fundamentally very different from their regulated peers. Independent power producers are highly cyclical, volatile, closely tied to commodity markets, typically have no economic moat, and rarely pay dividends.

Traditional income-seeking utility investors should steer well clear of this last group of companies. For others, however, Morningstar analysts believe that independent power producers are a compelling option for investors seeking deep cyclicals that can outperform during an economic recovery and expansion.

There are a total of 42 companies trading on the London Stock Exchange and listed in Morningstar's Utilities sector. Among them, Morningstar equity analysts rate National Grid (NG.), SSE (SSE) and United Utilities (UU.)

National Grid ****
Carries a Morningstar Rating for Stocks of 4 Stars, implying it is moderately undervalued by the market.
Dividend Yield: 5.39%.

SSE ***
Carries a Morningstar Rating for Stocks of 3 Stars, implying it is fairly valued by the market.
Dividend Yield: 5.19%.

United Utilities **
Carries a Morningstar Rating for Stocks of 2 Stars, implying it is moderately overvalued by the market.
Dividend Yield: 4.81%.

Morningstar data correct at time of writing, 4 September 2013.

Click here for a list of all LSE-listings in the Utilities sector.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
National Grid PLC1,224.00 GBX-1.73Rating
SSE PLC1,911.50 GBX-0.44Rating
United Utilities Group PLC1,140.00 GBX-0.39Rating

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Morningstar.co.uk Editors  analyse and report on shares, funds, market developments and good investing practice for individual investors and their advisers in the UK.