Sector in Focus: Utilities Stocks

Water company United Utilities and energy distributor National Grid both reported results recently. We reveal what Morningstar equity analysts think of the companies

Morningstar Equity Analysts 26 May, 2015 | 10:15AM
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National Grid's Full-Year Results Highlight Investor Benefits from New U.K. Regulatory Plan says Morningstar analyst Travis Miller

Dividend growth should accelerate

We are reaffirming our £8.15 per share fair value estimate and narrow moat and stable moat trend ratings for National Grid (NG.) after the company reported fiscal-year operating earnings up 9% year over year to 58.1p per share. This was slightly lower than our forecast, but we are maintaining our long-term outlook so the adjustment to fiscal 2014-15 results doesn't have a material impact on our fair value estimate.

In the first year of the new RIIO regulatory construct, National Grid was able to take advantage of the plan's financial incentives to post remarkable returns far greater than any other regulated utilities we cover. Management reported earning a 14% return on equity at its U.K. electric transmission business and a 14.2% return on equity at its U.K. gas transmission business. These businesses combined contributed 43% of Grid's operating profit for the year, helping offset lower earned returns on equity at its other businesses.

The most upside continues to be at its U.S. regulated utilities, which underperformed their allowed returns again this year. Part of the business plan this year is to achieve rate increases that will boost those returns. Although regulatory conditions are improving in Grid's Northeast U.S. service territories, we remain sceptical that this business will be able earn much more than the 9%-10% returns on equity that most other U.S. regulated distribution utilities earn, diluting the attractive U.K. business.

Management reaffirmed its long-term dividend policy and capital investment plans, all in line with our forecasts. Management recommended a 28.16p per share final dividend, resulting in a 2% increase from fiscal 2014 and in line with management's inflation-growth target. If Grid continues achieving returns like it did in the U.K., we think dividend growth should accelerate.

United Utilities Group Successfully Navigates 2010-15 Regulatory Period says Morningstar analyst Andrew Bischof, CFA

We are reaffirming our £8.50 per share fair value estimate, narrow economic moat, and stable moat trend ratings after United Utilities Group (UU.) reported fiscal year 2015 operating profit of £653.3 million, compared with £630.2 million last fiscal year. In the fiscal year, the company paid a 37.7p per share dividend, in line with management's annual dividend growth target of at least retail price index.

The company successfully completed the 2010-15 regulatory period, investing nearly GBP 3.8 billion and ending the period in the top quartile of utility performance. Management now turns its attention to the upcoming 2015-20 regulatory price control, which sets higher targets for operational efficiencies and more challenging financial targets. During the next five years, the company plans to spend more than £3.5 billion on capital investments, supporting regulatory rate base and modest earnings growth.

During the year, rev enue was up 1.9%, lower than the 3.8% nominal allowed increase (1.2% real, plus 2.6% RPI change) as management implemented a previously announced special customer discount, which was applied in the current fiscal year. Operating costs were kept in check, with lower operating expenses offsetting higher depreciation from asset additions and increased bad debt expense.

Management continues to outperform regulatory targets, which allows United Utilities to earn higher rates of return. We like that the company is reinvesting some of the earnings from outperformance back into regulated growth assets.

 

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 PLC845.37 GBX-3.56Rating
United Utilities Group PLC Class A990.80 GBX0.92Rating

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Morningstar Equity Analysts  Morningstar stock and fund analysts cover 2,000 mutual funds, 2,100 equities, and 300 exchange-traded funds.

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