Social Utility

Politics Is a Dirty Business, But Investors Are No Angels

It's fair enough when voters call time on a shareholder gravy train, as is happening with the utilities.
Photographer: Jack Taylor

"Political risk" is a wonderful bit of shareholder jargon that has its uses -- maybe if your fund is looking at Venezuela or Brexit Britain or somewhere. It acknowledges that an unpredictable world can interfere with your investment thesis. Sometimes, though, it just describes the perfectly natural unwillingness of voters to let business do whatever it likes.

Take the utilities. Companies that provide essential services to households and firms have been pretty safe ground for shareholders during difficult times. They come with regulated tariffs, high barriers to entry and state protection. They offer chunky dividends that yield more than the broader stock market.

That's provided comfort to fund managers in a world of ultra-low interest rates. Over the past decade, the net total return of European water, gas and electric utilities as tracked by MSCI has been about 67 percent, versus 62 percent for the broader MSCI Europe index.

Safe, Yet Supercharged

Net Total Return for European utility sub-sectors, tracked by MSCI, has mostly outperformed

Source: Bloomberg/MSCI

As interest rates become slightly more normal and bond yields climb, there are signs of utilities losing their special appeal. But politics is an even bigger threat -- and justifiably so.

After a decade of stagnating wages for many people, it's no longer palatable to let essential service providers make fat returns. A mix of price protection and cheap debt has enriched investors, without always doing much for the customer.

Macquarie, for example, won the nickname "Vampire Kangaroo" for its investment in British utility Thames Water. According to the FT and BBC, the Australian infrastructure bank made yearly returns between 15 percent and 19 percent, while saddling its asset with more debt and a record fine for sewage leaks. Macquarie has cited instead a 12.3 per cent internal rate of return -- hardly starvation rations.

So there's a real grievance that rewards haven't been fairly split between owners and the public. That fuels the rage of opposition politicians like Britain's Jeremy Corbyn or the leaders of Italy's Five-Star Movement, who want more state ownership of utilities. As expensive and impractical as that may be, it's popular with voters, and probably wouldn't compensate investors beyond the book value of their holdings.

The People's Portfolio

U.K. utilities have taken a beating as political battle-lines are drawn over the sector's future

Source: Bloomberg

The crusade crosses the political spectrum too. U.K. prime minister Theresa May's promise to tackle "rip-off" utility prices could depress water company earnings by 30 percent, according to UBS. Spain reportedly wants to cut payments for gas distribution and transport. The outlook -- for shareholders at least -- is bleak.

Yet politicians should tread carefully. Investor sentiment is fragile in politically charged times, as Brexit and Catalonia show. It's easy to chase away needed investment if regulations change too quickly, or become uncertain. Spain's about-turns on renewable energy, from slashing subsidies to resets of power prices, have done exactly that.

It's hard to feel sorry, though, for big holders of capital hunting long-term returns. Contract terms might need to be more balanced in customers' favor -- no bad thing given the excesses. But with interest rates still mild and inflation starting to creep back up, there's room to make money. So long as Corbyn and his ilk don't take power.

Not Worth It?

European utilities' dividend yields

Source: Bloomberg

Sector valuations will probably need to fall further to keep yield investors coming back. The easy pickings are gone, dividends have little room to increase and private companies need to share more financial benefits with their customers. If it makes things fairer, so be it.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Lionel Laurent in London at llaurent2@bloomberg.net

    To contact the editor responsible for this story:
    James Boxell at jboxell@bloomberg.net

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