Maybe recent stock market weakness has exposed better value in the utilities sector. Today I’m looking at National Grid (LSE: NG), United Utilities Group (LSE: UU) and Dee Valley Group (LSE: DVW).
Defensive qualities
I find steady, cash-generating and highly regulated utility providers attractive for their defensive qualities. They often come with high loads of debt, because their businesses are capital-intensive, and the regulators require utility firms to keep investing in infrastructure so that their services to consumers remains as efficient and reliable as is possible.
Well-known fund manager Neil Woodford turned his back on the utility firms a few years back, because, as I understand it, he feared that increasing regulatory demands might compromise investor total returns in the sector. It’s a valid point. However, so far, firms such as National Grid, United Utilities and Dee Valley Group continue to serve their investors well on total returns.
Full valuations
National Grid’s share price did weaken earlier this year, but has bounced back. Today, at a share price of 925p, the electricity and gas transmission system owner trades on a forward price-to-earnings ratio (PER) of just over 15 for trading year to March 2017, and City analysts following the firm expect an earnings uplift of 3% that year.
At 949p, United Utilities’ shares are down from the 1015p or so they reached at the beginning of the year, but earnings are falling. Expectations are for a 12% slide for the current year followed by a further 4% decrease for year to March 2017. Right now, the shares trade on a forward PER of just over 21, making the water and sewage service provider look quite pricey.
Fellow, but smaller, water supplier Dee Valley Group is similarly priced. At a share price of 1408p, the forward PER for year to March 2017 runs at just under 22. Earnings are falling: down 21% last year, down 10% this year and down a likely 4% next year.
It’s all about income
Should I pay too much attention to price multiples when investing in the utilities for income though? After all, the theory goes, stable cash flow from all those geographically captive customers should keep the cash taps flowing and, with a bit of luck, there’ll be enough left over for the directors to keep up with dividend payments.
The dividend situation for each firm looks like this:
|
|
Forward dividend yield year to March 2017 |
Times forward earnings cover the payout |
|
National Grid |
4.9% |
1.3 |
|
United Utilities |
4.1% |
1.1 |
|
Dee Valley Group |
4.4% |
1.04 |
National Grid looks like the most attractive proposition to me, based on its valuation multiple, the size of its dividend and the cover from earnings, and on the scope and scale of its operations.
That said, I’m not in a rush to invest in the utilities sector, because valuations look stretched to me. I’d be happier with PERs near ten, dividend yields well over 5% and cover from earnings of around 1.5 times. Despite the regulated monopolies that these firms enjoy, there’s still risk inherent in their business models that could call on copious amounts of cash, thus threatening investor total returns.
