Utility Stocks See Shares Spike as Investors Seek Income

Utility stocks have seen shares soar as investors look for stable stocks with a regular income. But these stocks now look expensive, what are the risks?

Emma Wall 22 July, 2016 | 12:02PM
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Emma Wall: Hello and welcome to the Morningstar Series "Ask The Expert". I'm Emma Wall and I'm joined today by Morningstar Equity Analyst, Andy Bischof.

Hi Andy.

Andy Bischof: Hello.

Wall: So we are here today to talk about utilities that’s your special subject. What is special about investing in utilities?

Bischof: Well, in utilities you really have safety and I think you have safety of income and you have safety in terms of overall business structure, the regulated environment. And I think that’s what we have seen recently in the U.K. you've seen very strong run up in both United Utilities and SSE recently based on this kind of flight to safety amid political uncertainty.

Wall: And that’s key isn’t it, because safety and income are two things that U.K. investors are desperate to get, both because of Brexit and indeed because of the incredibly low interest rate environment that we've had for than seven years now. But because of that these stocks are looking toppy aren’t they? They are looking fair valued.

Bischof: So SSE (SSE) we see about 4% overvalue which in the world of utilities is actually pretty good. But United Utilities (UU.) on the other hand we see about 20% overvalued and United Utilities will probably see pretty low earnings growth over the next eight years or so.

Wall: But that doesn’t necessarily mean that they don’t have a place in people's portfolio. Because these stocks they do a special role don’t they and that is the income.

Bischof: Exactly. SSE you are going to get a nice 5.5% dividend yield. You have 40% of the business that is regulated so there is certainty in some of the earnings news there. Then you have United Utilities which is your very typical very solid regulated utility, water utility. So 100% regulated earnings, you have very clear outlook for the next eight years. So it might not be high upper digit percent you are still going to get very nice return and dividend return.

Wall: I suppose all that does sound a bit too good to be true. So what are the risks investing in these stocks.

Bischof: So historically you have to worry about regulatory uncertainty, will you continue to get that favorable treatment from regulators and you also have to worry about interest rates. Historically utilities have underperformed in a high interest rate environment.

Wall: And of course not a problem in such a low interest rate environment. But we won't stay like this forever.

Bischof: Exactly.

Wall: Andy thank you very much.

Bischof: Thank you.

Wall: This is Emma Wall from Morningstar. Thank you for watching.

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
SSE PLC1,704.30 GBX-2.50Rating
United Utilities Group PLC Class A990.80 GBX0.92Rating

About Author

Emma Wall  is former Senior International Editor for Morningstar

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