Idea of the day: utilities not so safe anymore

UK utility companies are the worst performing sector on the FTSE 100 so far this year. As you can see in chart 1 below, all of the major UK utilities companies including National Grid, Centrica, Severn Trent, Southern & Scottish Electricity and United Utilities have suffered declines, even though the FTSE 100 has rallied for most of the past month.

What: UK utility companies are the worst performing sector on the FTSE 100 so far this year. As you can see in chart 1 below, all of the major UK utilities companies including National Grid, Centrica, Severn Trent, Southern & Scottish Electricity and United Utilities have suffered declines, even though the FTSE 100 has rallied for most of the past month.

How: The key driver for weakness in the utilities sector are energy price caps proposed by the Tory party. The latest development in this saga is that price cap legislation will be published on Thursday, suggesting that the utility lobby group has failed to change the government’s mind. The reason this is likely to have such a negative impact on utilities, and may continue to do so, is that utilities bosses now have a tough decision between maintaining dividends in the face of potentially depleted profits.

The dividend has been one of the only attractive qualities for utilities stocks in recent months, UK utilities have an average dividend yield of nearly 5.5%, compared with the 4.2% average dividend yield for the entire FTSE 100 index. Even though utilities are looking attractive from a valuation standpoint, Centrica’s P/E ratio is 11.6 vs. 25.5 for the entire FTSE 100, if utilities do strip away their dividend, which they have yet to do, then it could make these stocks even less attractive and we may see further downside in the coming weeks and months.

Chart 1:

Source: City Index and Bloomberg 

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