Investors Seek Out Utilities Stocks with Dividend Growth

Utilities stocks join the most popular stocks list last month, thanks to their income potential - alongside 2016 winners oil miners and troubled banking stocks

Karen Kwok 16 January, 2017 | 4:20PM
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Utilities stocks are among the most popular UK companies as chosen by Morningstar.co.uk – thanks to their income paying potential. The utilities provider National Grid (NG.) came in second on readers’ top stocks list last month, alongside peer Centrica (CNA) at number 10.

Financial and energy stocks also continue to be popular among readers in December, with Lloyds Banking Group (LLOY) topping the list of the most clicked on stocks for the last 15 months in a row. Energy stocks hold interest for readers thanks to the oil price rally in the second half of the year.  Supermarket stock Tesco (TSCO), telecoms stock Vodafone (VOD) and pharmaceuticals company GlaxoSmithKline (GSK) were also on the December list.

National Grid Aims to Boost Dividend

National Grid has grown into one of the largest utilities in the world since UL regulators unbundled energy distribution, transmission, and supply in the 1980s. Current UK regulation also allows for annual inflation adjustment, protecting National Grid from falling earned returns as costs rise. As National Grid earns about 30% of its profits from the United States, a weak sterling helped improve its US earnings and growth. The stock gained 6.2% in 2016.

Travis Miller, director of utilities equity research for Morningstar said the company’s management proposed 1% dividend increase in 2017 and similar growth outlook given modest inflation lags far behind dividend growth from most other regulated European and US utilities.

Miller explained National Grid's ability to return that much capital to shareholders is a credit in part to management's ability to secure low-cost debt and construct a highly leveraged cash flow stream. Miller believes National Grid will easily meet management's target to increase the dividend at or above the inflation rate for the foreseeable future.

National Grids also made the list of the January’s edition of the Morningstar Europe Core Pick List, which features the most attractively valued European-domiciled companies that possess sustainable competitive advantages. The stock is rated three-star by Morningstar analysts, meaning analysts believe the stock is trading at their fair estimate for the share price.

Another utilities provider Centrica, in the contrary, left the list of the January’s edition of the Morningstar Europe Core Pick List. Centrica increased its 2016 earnings guidance and confirmed operating cash flow will be well above management's initial guidance exceeding £2 billion, said Morningstar equity analyst Charles Fishman.  The stock gained 12.9% in 2016.

The company’s subsidiary British Gas is the largest natural gas retailer in the UK, and it is Centrica’s largest earnings contributor. Fishman said although British Gas remains the dominant market share leader, its share of natural gas retail customers has steadily declined, but still remains over 35%. Morningstar analysts believe that Centrica could begin to increase its dividend again starting in 2017. The stock is rated three-star by Morningstar analysts, meaning they believe it is trading at fair value.

Lloyds Takes Top Spot for 15 Months

Despite Lloyds loss 10.6% in 2016, investors continue to monitor the stock as Lloyds has been on top of the most click stock list on Morningstar.co.uk over the past 15 months.

Stephen Ellis, director of financial services equity research for Morningstar believes Lloyds is now one of the sturdiest banks in Europe. It nearly destroyed itself in 2008 and the UK government ended up with 43.5% of the combined group. Now, after years of bailouts and setbacks, the bank has essentially righted itself, and the government has largely sold down its stake, said Ellis. Ellis added that Lloyds' 2015 dividend surprised to the upside, and the firm is positioned to return substantial capital going forward. The stock is rated three-star by Morningstar analysts, meaning they believe it is trading at fair value.

Another bank HSBC (HSBA) came fifth on the most clicked stock list in December. The stock gained 29.6% in 2016. The benefits of the bank’s geographic diversification were highlighted during the financial crisis. Although HSBC took large losses in its North American segment, its other operations picked up the slack, and the bank escaped without reporting a loss, said Ellis. Ellis believes near-term dividend growth is likely to be meagre, at best. The stock is also rated three-star by Morningstar analysts, meaning they believe the share price is at fair value.

Financial services stock Legal & General (LGEN) came sixth on the readers’ list in December. The stock lost 2.3% in 2016.

Mining Stocks Rally

With the significant rises in oil prices seen this year, so too have shares of the oil and mining companies gained over the second half of the year. The depreciation of sterling following a Brexit vote also benefitted mining stocks, as many mining and oil producers have revenues earned in US dollar.

BP (BP.) and Royal Dutch Shell (RDSB) came third and forth on the most clicked stock list among Morningstar.co.uk readers in October. Shares of Shell gained 61.5% in 2016 while BP was up 52.3% in the year. Both stock are rated three-star by Morningstar analysts.

Morningstar analysts believe that while Shell currently offers a scrip dividend – a provisional certificate to be exchanged for future cash – they anticipate that the company can return to paying a full cash dividend by 2019 with an improvement in operations and a recovery in oil prices.

While BP will run a cash flow deficit through 2017, analysts forecast the company can cover a full cash dividend at $55 oil price per barrel in 2018, one of the lowest levels among European integrate.

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
BP PLC483.00 GBX0.09Rating
Centrica PLC141.15 GBX-1.91Rating
GSK PLC1,774.50 GBX-0.20Rating
HSBC Holdings PLC693.40 GBX0.29Rating
Legal & General Group PLC247.90 GBX1.10
Lloyds Banking Group PLC54.80 GBX-1.76Rating
National Grid PLC889.40 GBX-11.50Rating
Tesco PLC315.00 GBX0.86Rating
Vodafone Group PLC73.50 GBX-0.92Rating

About Author

Karen Kwok

Karen Kwok  is a Reporter for Morningstar.co.uk

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