I am looking for quality UK shares to add to my portfolio. There are currently some well documented macroeconomic pressures, such as rising inflation, increasing energy costs, and the supply chain crisis affecting the UK and world economies. With this in mind, I thought it would be good to review some defensive FTSE utilities stocks as potential options for my portfolio.
Why utilities stocks?
Traditionally, utilities stocks have outperformed other sectors in times of economic uncertainty. In such times, utilities can be popular to buy and hold. As a bonus, a common characteristic among these UK shares is that they can offer high dividends too.
Utility companies supply the energy and water needs for the world’s population. Different firms provide electricity, gas, and water. They can also be responsible for maintaining delivery systems and production sites as well. The demand for energy and water will never cease, which gives these utilities stocks defensive traits. Good defensive shares can be the foundation of any investment portfolio in my opinion.
Types of utilities stocks
There are a number of different ways of producing and supplying energy in the modern day and age. There are renewable energy firms, nuclear power plants, hydro-electric and tidal power, as well fossil fuels. In addition to this, there has been a huge shift in recent times to move away from fossil fuels towards greener alternatives. This is linked to the rise in ESG investing which is a focus on environmental, social, and corporate governance policies.
Different utility companies perform different functions. I thought it would be good to define these before I explore the few UK shares I have chosen to review for my portfolio.
- Energy generating: these firms produce or supply energy and or water to customers only.
- Energy network operating: these firms operate energy grids and are responsible for matching the supply of energy or water with the current demand in a given territory.
- Network maintenance: these firms are responsible for maintaining energy networks, wastewater, or sewage works. Installation may also be part of their offering.
It is worth noting that there are some firms that can do all three of the above functions while others choose to specialise.
A UK share I really like
My first pick is National Grid (LSE:NG). National Grid is the electricity system operator for the UK. It is responsible for ensuring homes and businesses in the UK have access to the power that they need, whenever they need it. It also operates in the US with over 20m customers in Massachusetts, New York, and Rhode Island.
As I write, shares in National Grid are trading for 997p. A year ago, shares were trading for 911p, which is a 9% return. At current levels, it has a forward price-to-earnings ratio of 24, which I believe is a fair price.
UK shares that consistently pay a dividend are tempting. National Grid has a dividend yield of just over 5%. This is higher than the FTSE 100 average of 3%. Furthermore, it has paid a dividend for every year for the past 10 years, and the yield has never fallen below 3.5%, which is a good level of consistency. Performance has been fairly consistent too. The pandemic did affect performance but this was the case for most utilities stocks.
There are credible risks to National Grid. Rising energy prices could hamper investor sentiment which could affect performance and share price. Furthermore, regulation is very tight in the utilities industry which can affect profit margins and capital spending.
I would add National Grid shares to my portfolio at current levels.
UK’s largest publicly listed water company
United Utilities (LSE:UU) is the largest publicly listed water company in the UK. It supplies drinking water and wastewater services to over 3m homes and 200,000 businesses in the North West of England.
As I write, shares in United Utilities are trading for 1,070p. A year ago, shares were trading for 896p, which is a 19% return. It has a P/E ratio of 16, which I believe is cheap right now.
Like National Grid, United Utilities also has a good dividend yield, currently standing at over 4%. A recent trading update announced at the end of September for Q1 made for good reading. It confirmed that results for the half year ending 30 September, to be announced soon, are ahead of expectations. It also said they should be higher than the same period last year.
This is pleasing, as United Utilities’ FY results last year were impacted by Covid-19, similar to lots of other UK shares. Furthermore, a new way of billing customers may have shown revenue and profit decreasing. This trading update vindicates my thinking that the decreasing revenue and profit weren’t due to negative trading or other issues, but rather the new way of billing.
United Utilities also has risks. Rising inflation and rising costs that may be difficult to pass on to customers is a credible threat. This could affect investor sentiment, performance, share price, and in turn any dividend returns too. Regulation in the water industry is also strict and ever-changing.
I would add United Utilities shares to my portfolio at current levels.
One UK share I’m definitely avoiding
Centrica (LSE:CNA) is the largest supplier of natural gas utilities to domestic UK customers and also one of the UK’s largest electricity suppliers. British Gas is Centrica’s best-known brand.
The recent spike in energy prices has resulted in many smaller firms going bust. I think British Gas is too big for that but operations and investor sentiment have been affected.
As I write, shares in Centrica are trading for 67p per share. A year ago, they were trading for 45p, which is a 48% return. Centrica shares have been on a downward trajectory for some years and are still below pre-market crash levels.
Centrica has been boosted by new customers from the firms that have gone bust due to rising energy prices. It has also sold non-core businesses to focus on core operations and carried out a restructuring to streamline operations.
My issue with Centrica has been its falling market share in recent years. Furthermore, the current volatility of gas prices, which it has no control over, also puts me off. The negatives outweigh the positives currently for me.
I would avoid Centrica shares just now.
Jabran Khan has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.