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Utilities lose, telcos win as Europe investors focus on regulation
December 2, 2013 / 12:20 PM / 4 years ago

Utilities lose, telcos win as Europe investors focus on regulation

* Years of falling wages pressure politicians to act

* UK utilities seen most at risk from politics

* European telecoms to benefit from EU regulation

By Toni Vorobyova

LONDON, Dec 2 (Reuters) - Political intervention and regulation are becoming increasingly important in shaping the views of European equity investors, prompting some to ditch banks and utilities and creating opportunities in transport and telecom stocks.

Four years of falling or flat real wages in Europe, stretched state finances and a desire by authorities to step up regulation to avoid a repeat of the financial crisis have led governments to exert more influence in corporate affairs.

Banks are being urged to boost capital, reducing their ability to reward shareholders through dividends.

Utilities, particularly in Britain, are under pressure from politicians to cut costs for consumers, which will leave the companies with lower profits and less cash for investment.

Investors are thus paying more attention to what authorities are doing, prompting both Citi and HSBC to pick regulation as a key European equity investment theme for 2014.

British utilities are seen as among the most exposed, facing widespread public discontent over rising fuel bills against the background of an often uneasy coalition government and a parliamentary election in 2015.

In the two months since the opposition Labour Party proposed freezing energy prices until 2017 if it wins power, the Thomson Reuters UK Utilities Index has dropped 7.4 percent , strongly underperforming a broadly steady FTSE 100.

Over the weekend, Prime Minister David Cameron responded with his own plan to clamp down on energy costs, prompting analysts to forecast lower earnings for the likes of SSE and Centrica.

POLITICAL ELEMENT

“There is always a political element at the best of times, but it’s become more acute now that we’ve had some years of negative real wages in the UK and the recent energy bill increases have thrown this into to focus,” said Michael Clark, portfolio manager at Fidelity, who said he might reduce holdings in energy companies.

“From an investment point of view, I don’t know which way things are going to go in terms of who wins the election in 2015, but we should be a little bit careful of expecting too much from these companies because of the political pressure.”

In the past 90 days, top analysts have cut dividend forecasts for FTSE 100 utilities - including SSE, Centrica and Severn Trent - by 0.4 percent for next year and 1.5 percent the year after, according to StarMine SmartEstimates.

Foreign players may also be affected, with Germany’s RWE , last week scrapping plans to build the world’s largest offshore wind farm in British waters amid uncertainty over government renewable energy subsidies.

Indeed, RWE and peer E.ON show the possible impact of policy on the sector, with a state-ordered exit from nuclear power and competition from green energy sources leaving them less cash for investments and dividends.

Spanish utilities also face problems after the finance ministry withdrew 3.6 billion euros ($4.9 billion) in financing for the electricity sector over the weekend, choosing to focus on reducing the government deficit but in so doing raising costs for indebted companies.

Iberdrola and Endesa shares fell 2.2 percent on Monday, while Gas Natural lost 1 percent.

HOLDINGS REDUCED

Colin Morton, portfolio manager at Franklin Templeton, meanwhile, has already reduced his holdings, taking about 2 percent of his money out of UK utilities.

“I still like the companies but unfortunately their fortunes have been hijacked ... The problem is that we are going to now be watching things like opinion polls like a hawk for the next 12 to 18 months,” he said.

“It would make me nervous of UK banks because a lot of people own shares like Lloyds because they think they are going to start returning a lot of money to shareholders, and under a Labour government I think that’s not very likely.”

Lloyds is expected to start paying cash to shareholders next year, when StarMine SmartEstimates forecasts a dividend of 2.9 percent, rising to 5.0 percent the following year to overtake the FTSE 100’s forecast average yield of 4.2 percent.

The pressure on dividends could spread across Europe, where the European Central Bank’s Asset Quality Review, stress tests and the prospect of more regulation will put the spotlight on balance sheets and capital ratios.

“If regulators tighten rules on aggressive distribution of profits, we would highlight SEB and Handelsbanken as being vulnerable,” HSBC said in a note.

SEB and Handelsbanken both offer a dividend yield of 3.5 percent, above the 2.5 percent average for STOXX Europe 600 banks, according to StarMine.

Politics, though, can create winners as well as losers, with telecoms expected to benefit from the European Union’s drive to overhaul the sector, including by encouraging investment in broadband network infrastructure.

Here, winners could include Vodafone and Deutsche Telekom, according to HSBC.

Back in Britain, some transport companies such as bus and rail operator Go-Ahead could benefit from a new approach to rail franchising. The new policy, which seeks to restore confidence in the privatised network after costly errors in the bidding process, includes staggering the award of franchises and is expected to improve profits and reduce risks.

“Go-Ahead Group is the stock most exposed to rail franchise wins, in our view. These could drive upgrades to consensus earnings of 20-30 percent,” HSBC analysts wrote.

“Importantly, they (the franchises) look set to be awarded on better terms than they previously were, meaning that the impact on share prices could be amplified further still.”

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