U.K. Water Providers Valued Amid Market Plunge, Analysts Say

Severn Trent Plc (SVT), Pennon Group Plc (PNN) and United Utilities Plc are offering refuge to investors after the sell-off in global stock markets because the U.K. water providers have stable, inflation-linked earnings, analysts say.

European stocks have plunged, sending the benchmark Stoxx Europe 600 Index 19 percent lower this year as investors showed concern that U.S. economic growth is faltering and Europe’s debt crisis is worsening. In contrast, United Utilities shares fell 2 percent and Severn Trent dropped 3 percent.

British water companies are regulated by the Water Services Regulation Authority, which sets the price they can charge consumers every five years based on a formula linked to inflation, giving investors some protection against rising prices and recession. The benchmark 10-year gilt yield hit a record low on Aug. 18.

“If you think that returns in the U.K. are stable and you think that you’ve got a currency that’s cheap, why would you want to buy bonds, if you can buy one of these regulated networks on a higher yield?” said Mark Freshney, an analyst at Credit Suisse in London. “Equity markets appear cheap relative to bond markets and what you’re seeing is people looking around that see U.K. returns are attractive.”

Freshney has an “outperform” rating on Pennon and United Utilities. He is “neutral” on Severn Trent.

Dividend Stream

While European electricity and gas providers have cut dividend payments as fuel price inflation and government levies have reduced earnings, U.K. water companies are seeking to increase them by more than inflation.

Pennon aims to increase its dividend by 4 percent above inflation every year through 2015. Severn Trent is committed to a 3 percent increase above the U.K.’s Retail Price Index over the same period, while United Utilities is targeting a 2 percent rise. RPI remained at 5 percent in July, according to official data published on Aug. 16.

“U.K. waters are the one safe haven among all the European utility stocks and there is still healthy demand,” UniCredit analyst Lueder Schumacker said in a telephone interview. “They’re regulated, so they’re safe and predictable.”

Pennon shares rose 17.5 pence, or 2.8 percent, to 641 pence in London. Severn Trent gained 28 pence to 1,435 pence. United Utilities increased 9 pence to 580.5 pence.

Utilities Saddled

In Italy, Germany and Finland utilities are saddled by government plans to impose levies. The industry also has to invest heavily to meet the European Union’s renewable energy targets while rising fuel price inflation is curbing consumer demand for heating and power.

EON AG, Germany’s largest utility, has dropped 36 percent this year and announced plans to reduce dividends this month. RWE, the second-biggest, said on Aug. 9 that full-year recurrent net income, the metric used to calculate dividend payments, will be 35 percent lower in 2011.

Veolia Environnement SA (VIE), this year’s biggest loser in the STOXX 600 utilities index, has said dividends may be reduced in 2011. Power generator EDP-Energias de Portugal SA may also have to reconsider its dividend if the country’s economy fails to rebound, according to Deutsche Bank AG analysts.

The defensive appeal of utilities stocks may already be reflected in share prices, according to strategists such as Andrew Milligan at Standard Life Investments Ltd.

Slow Growth World

“If we are entering a slow growth world with limited earnings or we’re entering an environment when we’re actually going to see a recession for a couple of quarters until policy makers respond, the more defensive stocks will do well,” said Milligan, head of global strategy at Standard Life in Edinburgh, in a telephone interview. “The difficulty is that story has already been well priced in and therefore I would hardly say they are value.”

An agreed bid to buy Northumbrian Water Group Plc (NWG) for 2.4 billion pounds ($3.9 billion) this month by Cheung Kong Infrastructure Holdings Ltd. (1038) has raised the possibility of the three remaining listed water companies also becoming takeover targets, analysts say.

CKI, controlled by Hong Kong billionaire Li Ka-shing, said in June it was considering a cash offer for Northumbrian, sending shares of the Durham, England-based utility up 8 percent.

CKI, which led a group that bought Electricite de France SA’s U.K. power networks for 5.8 billion pounds in July 2010, agreed to pay 465 pence per share for Northumbrian Water, a premium of 26 percent over the company’s closing share price on June 23.

Infrastructure Funds

“It’s a one in four or five chance” that another U.K. water company will be subject to a takeover bid, said Peter Atherton, an analyst at Citigroup Inc. in London. Infrastructure funds still have money ready to invest and remain interested in the industry, he said.

Atherton recommends investors “buy” all three stocks.

“There is a lot of speculation in the media at the moment about water company takeovers,” Shaun Robinson, a spokesman for United Utilities, said in an e-mailed response to questions. “We have not received any offers, and we’re not able to get drawn into ‘what ifs’ and speculation. Our bottom line is always to act in the best interests of our customers and shareholders.”

Sara Evans, a spokeswoman for Pennon, said the Exeter-based utility wouldn’t comment. Sonia Southern, a spokeswoman at Severn Trent, said in an e-mail that the company was unable to provide a comment on this occasion.

To contact the reporters on this story: Ben Edwards in London at bedwards35@bloomberg.net; Kari Lundgren in London at klundgren2@bloomberg.net

To contact the editor responsible for this story: Will Kennedy at wkennedy3@bloomberg.net

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