United Utilities (LSE: UU) could be on the verge of receiving a takeover offer, according to market rumours. There might be other reasons to invest in its shares, however, although there are some obvious risks with UU.
If you are after a near risk-free trade, you should rather buy either Unilever (LSE: ULVR) or Reckitt (LSE: RB), in my view. Here’s why…
A pricey bet
Goldman Sachs, Societe Generale and Bernstein have all raised their UU price targets in recent days. If they are right, pre-tax gains of at least 10% could be on the cards from its current level of 866p, which is closer to its 52-week low of 748p than to its 52-week high of 1,045p. The shares are down 6% in 2015.
I suspect that most utilities have become a less enticing yield play based on their net leverage and the projected level of growth for their cash flows and dividends. If this holds true, then United Utilities is likely to underperform other rivals, also in the light of its 20x forward earnings multiples.
It’s not cheap, and if you are willing to pay that much for any stock, you should snap up Unilever instead.
A compelling buy
Unilever has surprised investors twice this year, reporting encouraging quarterly growth figures and a decent level of profitability. The problem with Unilever, if any, is that investors have doubts about the prospects for emerging markets, where its strength lay between early 2009 and mid-2013, during which period ULVR rose 30% a year on average.
Analysts at HSBC trimmed their price target to 3,050p on Thursday, and I have to agree that higher capital appreciation to the end of the year might be difficult to achieve from its current level of 2,570p. Like most stocks, ULVR has fallen a lot (-11%) since 6 August, but fundamentals remain solid.
It’s flat for the year, having outperformed the FTSE 100 by about four percentage points.
This is a great buy if you are after long-term value.
Buy or sell?
Based on its earnings multiples, Reckitt is 20% more expensive than United Utilities and Unilever, and its valuation is even more demanding than that of the other two based on its core cash flows multiples. Is RB an obvious sell, then?
This is not an easy call, really, and even brokers have different views. JP Morgan rose its price target to 6,300p last week; HSBC decided to cut its price target to 5,900p on Thursday; similarly, Credit Suisse joined those in the bear camp at the end of August (6,100p).
Well, its shares now trade at 5,744p, yet based on fundamentals, which are strong, Reckitt is the same company whose equity valuation stood at its all-time record of 6,300p only a month ago. Its rich valuation notwithstanding, its stock has proved to be more defensive than ULVR since 6 August, but UU has been more resilient in recent weeks.
