National Grid (LSE: NG), United Utilities (LSE: UU), Pennon Group (LSE: PNN), Severn Trent (LSE: SVT) and SSE (LSE: SSE) have been some of the market’s strongest performers over the past five years.
However, with an interest rate hike on the horizon, as well as the threat of increased sector regulation and stretched valuations, it could be time to sell these outperformers and book gains.
Rates up, prices down
As I’ve written about before, many investors fail to realise that rising interest rates will have a negative effect on share prices.
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According to City analysts, based on data analysed over the past few decades companies, with defensive qualities have seen their share prices fall as interest rates rise. This means companies like National Grid, United Utilities, Pennon, Severn Trent and SSE, all of which are well known defensive investments, are likely to see share prices fall when interest rates rise.
Unfortunately, all five companies above also look expensive at current levels, increasing the possibility that investors will sell up and look for other opportunities when interest rates begin to rise
Expensive shares
According to City figures, National Grid is now one of the FTSE 100’s most expensive shares, compared to historic figures. The company currently trades at a forward P/E of 15.6, compared to its five year average of around 12. What’s more, National Grid’s current dividend yield of 5%, is much lower than its five year average of 5.9%.
Similarly, SSE, Pennon, United Utilities and Severn Trent are all trading at higher than average valuations, as seen in the table below.
| Company | SSE | United Utilities | Severn Trent | Pennon | National Grid |
|---|---|---|---|---|---|
| Current P/E | 12.0 | 19.0 | 21.5 | 18.4 | 15.6 |
| Five year average P/E | 11.5 | 16.2 | 16.0 | 14.8 | 12.0 |
| Current yield | 6.0% | 4.4% | 4.3% | 3.9% | 5.0% |
| Five year average yield | 6.0% | 5.2% | 4.8% | 4.1% | 5.9% |
As you can see, all of the companies above are more expensive now than they have been during the past five years.
Other issues
Aside from rising interest rates and higher than average valuations, there is another factor that indicates you should sell these utilities.
The impending threat of increased regulation in both the water and power industries is becoming concerning. Indeed, if regulators do decide to force companies to lower customer bills, profits will come under pressure, dividends could be cut and valuations would collapse.
For example, United just submitted a revised pricing and investment plan for 2015 to 2020 to the UK’s water regulator Ofwat. If the plan is approved United will be able to raise customer prices to protect investment and the dividend.
Ofwat is expected to reply around the end of August. However, the regulator has already blocked an 8% price hike proposed by the country’s biggest water company, Thames Water, noting that the increase was not justified.
If Ofwat demands that United cuts customer bills, as the regulator did during 2010, United’s payout could be cut by a double-digit percentage. A dividend cut of 10% is bound to send investors running for the exit.
