UK water companies have "five years of clarity ahead" and while returns will be lower than in previous years, JPMorgan reckons investors are underestimating potential gains.
Severn Trent PLC (LSE:SVT) is the "top pick" for the investment bank, over United Utilities Group PLC (LSE:UU.) and Pennon Group PLC (LSE:PNN, OTC:PEGRY), with the latter downgraded to a 'neutral' rating after its relative performance since agreeing a rights issue last month.
In trading updates last month, all companies said they have accepted regulator Ofwat's final determinations for the next five-year period, with each also extending their dividend policy of growth in line with CPIH to March 2030.
"While we acknowledge that rising bond yields are a headwind for regulated utilities, we believe that investors are underestimating the combination of sector growth and a regulatory regime that protects investors from inflation and passes through the higher cost of capital to customers while providing a framework that gives well-run companies the ability to outperform base returns," analysts at the bank said in a note to clients.
Forecasts for the period "conservatively" assume 50-70% less return on regulatory equity (RoRE) outperformance versus recent years, and 60% lower asset growth estimates than industry forecasts post-2030.
For both Severn Trent and United Utilities positive 'overweight' ratings were reiterated, with SVT seen as offering "sector-leading" regulatory capital value (RCV) growth and outperformance, "underpinned by its best-in-class track record".
For UU, the upside is seen to conservative assumptions for outperformance in the next regulatory period, while in the analysts' view the shares "pricing in no outperformance in perpetuity".
The investment bank said it expressed an investment preference for electricity networks rather than the UK water subsector, owing to higher growth and return expectations for power companies.