Utilities have the unfair reputation of boring, but safe choices of the rather uninspired investor. Still, this year investors in U.K. stocks might find that utilities deliver some excitement.
There are three main tailwinds that may lift the sector this winter. They couldn't come too soon enough, either, as utilities have been lagging behind. An index of key industry players on the London Stock Exchange has fallen more than 7% year to date, while the FTSE 100 has returned almost 12% according to data from FactSet.
The first tailwind is global, and has to do with the bottoming of the price of oil and other commodities. These are likely to lift inflation everywhere, and utilities are generally a good bet for investors who seek shelter from the effect of price rises on their portfolios; they can generally increase prices in line with inflation.
The other two tailwinds come from the unique position in which the U.K. finds itself, both geographically and politically.
Geographically, Britain is close to the European continent (to the chagrin of hard-line Brexit supporters, who would want nothing to do with Europe once the U.K. leaves the European Union). This means that in the event of a harsh winter, U.K. imports of energy from the continent, especially from France and the Netherlands, would spike.
With France, there might be a problem. An article published by the Financial Times on Friday draws attention to the fact that several French nuclear reactors have had to close because of safety concerns. Therefore, there may be spikes in electricity prices if demand is high on cold winter days in the U.K., as supply from abroad will be tight.
Britain has relied on imports for around 7% of its energy needs this year, the article said, adding that business customers already have seen price increases of 10% to 12% for electricity because of the weak pound.
This brings us to the third tailwind, the political one. The pound lost around 18% to the dollar after the U.K. voted in June to leave the EU. Although initially this may look like a headwind as it makes imports more expensive, it could turn into a tailwind for utilities because they could use it as a reason to push through price increases that regulators otherwise might frown upon.
National Grid (NGG) is a distributor of electricity and gas that has a monopoly in England and Wales. The company is tightly regulated, which means it is not free to decide as it pleases what price increases to put in place, nor what amount of cash it can return to shareholders.
Despite this, National Grid has paid a dividend for each of the past 20 years. This makes it very popular with institutional investors, which own more than two-thirds of the free float.
It looks a bit pricey compared to its five-year average, but not massively so. It trades at a price/earnings multiple of 16.8x vs. its five-year average of 13.2x, while its dividend yield is 4.6% compared with a five-year average of 5.2% according to FactSet data. National Grid reports earnings for the quarter ended in September on Nov. 10.
Centrica (CPYYY) is the biggest supplier of gas and electricity. It owns giant British Gas and has suffered particularly badly among U.K. utilities recently. Its stock lost 11.7% over the past three months. It was partly hurt by remarks by British Prime Minister Theresa May, who seemingly attacked utility companies for not offering customers the best deal and not encouraging them to switch to get better prices.
In response, CEO Iain Conn said Centrica was "facing massive competition and huge pressure on margins" from more than 40 rival operators, according to the Financial Times. Hardly the stuff to appease investors.
Still, optimists could see this as a good buying opportunity; the stock trades at a P/E of around 13.7x vs. the five-year average of 19.4x.
SSE (SSE:LON) is the second-biggest energy supplier in the U.K. This one does not have an ADR, so investors looking for exposure should go through a broker that has access to companies listed on the London Stock Exchange. SSE is loved by institutional investors; they make up almost 82% of the float.
The utility company, which also has a 20-year record of consistently rewarding shareholders with dividends, has a juicy dividend yield of 5.7% -- its five-year average level. On a current P/E of 34.2x, it looks expensive until investors see the five-year average, which is 39x.
Earlier this month, SSE announced it would sell 16.7% in gas distribution business Scotia Gas Networks to Abu Dhabi Investment Authority for £621 million ($756 million) and said it would distribute the proceeds to shareholders. Anticipation is high ahead of the company's results release on Nov. 9.