Opportunities in Utilities Despite Dividend Cuts

VIDEO: A number of utilities companies have already cut their dividends, but Morningstar analyst Tancrede Fulop thinks there are buying opportunities in the sector 

Holly Black 6 April, 2020 | 1:23PM
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Holly Black: Welcome to Morningstar. I'm Holly Black. With me is equity analyst Tancrede Fulop. Hello. Thanks for joining us.

Tancrede Fulop: Hello, Holly. Thanks for having me.

Black: So, one of the sectors you look at is utilities, so that's energy firms and the like. How are they being affected in the current sell-off?

Fulop: They tumbled basically in line with the market, despite being a bit less exposed than other sectors. This is because they were a bit overvalued before the market fall. And so, in terms of impact, there's little impact. So, if you look at the valuation of the sector, you have an impact of the downstream part of the value chain, which is the retail supply of energy to households and business. And over the last weeks the consumption of gas and electricity declined between 10% and 20% in Western European countries. So, you have an impact on that part of the business and also, you will have an increase in bad debt provisions because customers are not able to pay.

And if you look at the upstream part of the business, power generation, its impact this year is limited because the power pollution is mostly hedged in advance at high power prices, but you could have an impact in the next year because since the beginning of the crisis power prices have tumbled quite significantly.

Then companies with exposure to E&P like Centrica, there is a huge impact because of the collapse of oil and gas prices. LNG also is massively affected because of the drop of gas prices. And finally, you have an impact for waste management companies like Veolia, (indiscernible) and Suez, because you have a massive drop of industrial pollution. So, we have much less waste from industrial companies.

Black: So, one good thing about these businesses is they're quite defensive because we still need gas and electricity regardless of what's happening. And so, that makes them quite popular with income investors because historically they've paid quite reliable dividends. But what is the outlook for those dividends now if these companies are coming under pressure?

Fulop: Yeah. As you mentioned, it's theoretically a defensive sector. But unfortunately, over the last days, there was a wave of dividend cuts. And this reflects more government pressure than balance sheet pressure. A good example of that is EDF and Engie, which cut their dividend yesterday. It's because the French state is a shareholder of the companies and the French state asked every companies in which it holds a stake not to pay any dividend this year. Then, in Germany, the German government asked every listed companies not to pay any dividends to be eligible to receive financial support. So, that puts dividend of E.ON and RWE at risk. Centrica also cut its dividend for this time which is very weakly positioned that reflects balance sheet pressure and I expect 2021 dividend to be cut too.

That said, Veolia also halved their dividend. So, yeah, finally, so the sector is supposed to be defensive, you had cuts and I expect potentially more cuts.

Black: Okay. So, you mentioned quite a few companies there where the dividends have already been cut or are about to be. Are there any stocks in this sector that you still like?

Fulop: Yeah. Against the current uncertain backdrop, I will go for (indiscernible) which means business and geographic diversification and exposure to midstream, so (indiscernible) end to really reverse. So, I like Enel. Enel maintains its dividend plans for 2022, also ready to achieve its 2020 guidance and has high exposure to renewables. It's probably one of the global leaders and high exposure to energy networks for which you see impact from COVID will be limited. Otherwise, there is also Orsted, which is close to my fair value estimate, is a global leader in offshore wind and we'll benefit from any pullback to get entry points in Orsted.

Black: Oh, that's a great point. This could be the time to get into renewable energy. Tancrede, thank you so much for your time. For Morningstar, I'm Holly Black.

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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Holly Black  is Senior Editor, Morningstar.co.uk


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