The utilities sector has been a great place in which to invest during the last five years. That’s not only because of the superb dividends which have helped investors to overcome low interest rates, but because of the superb capital gains that have been recorded.
For example, while the FTSE 100 has risen by just 12% in the last five years, National Grid (LSE: NG) is up by 56%, while water services peers United Utilities (LSE: UU) and Severn Trent (LSE: SVT) have soared by 60%. Add to this their market-beating dividends and their annualised total returns have been nothing short of stunning.
Looking ahead, though, all three companies are likely to suffer from rising interest rates over the medium to long term. As highly indebted businesses, they are likely to pay higher costs to service their borrowings than is currently the case, which may act as a brake on both their profitability and also on investor sentiment. Furthermore, with the 2020 election having the potential to see a Labour government, the threat of nationalisation of various utilities is still open for debate.
However, the reality is that the utility sector remains hugely appealing and has a very worthwhile risk/reward ratio. The pace of any tightening of monetary policy is unlikely to be anything but pedestrian, and the political risk for the likes of National Grid and water services companies such as United Utilities and Severn Trent is far lower than for their domestic energy supply peers, which seem to be an easy target for politicians of and the media.
With National Grid trading on a price to earnings (P/E) ratio of 15.8, versus 21 for United Utilities, and 23.4 for Severn Trent, it has the most upward re-rating potential. Furthermore, National Grid’s yield of 4.7% is much higher than that of the other two stocks — United Utilities’ is 3.9% , and it’s 3.6% at Severn Trent. In addition, National Grid has the most upbeat dividend growth prospects, with the dividend per share expected to rise by 2.5% next year, compared with increases of 2.1% for United Utilities and 1.9% for Severn Trent.
Of course, where National Grid lacks appeal, relative to United Utilities and Severn Trent, is bid potential. In previous years, Severn Trent has been the subject of takeover attempts, while United Utilities has been a rumoured takeover target for various infrastructure funds. As such, the two water companies could offer considerable capital gains over the medium to long term if bid approaches are made. However, with National Grid being so much cheaper and having a far greater yield, it seems to be the one to buy out of the three stocks.
While all three have excellent total return potential in the coming years, National Grid could prove to be the best performer and, while 56% gains in the next five years may not be achieved, it certainly has the potential to continue to beat the FTSE 100.
