Analysts at Goldman Sachs have initiated coverage of the big three UK water stocks in a cautious note pointing out that the upcoming regulatory review brings risks to returns for the sector.
The Goldman analysts initiated Severn Trent PLC (LON:SVT) with a ‘sell’ rating and a price target of 1,881p, and started both Pennon PLC (LON:PNN) and United Utilities PLC (LON:UU) with ‘neutral’ ratings and price targets of 749p and 778p respectively.
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They said: “At the start of a regulatory review cycle, faced with the prospect of rising interest rates and risk from changes in political leadership, we believe that the UK water sector is poorly placed relative to the wider European opportunity set.”
The analysts added: “We believe the next review will add further pressure to returns, with current valuations unattractive in this context.”
They pointed out that the UK regulator Ofwat released its final methodology in November 2017 for the AMP 7 review which covers full tears 2020 to 2025).
The analysts said: “While there is insufficient information to gauge the dividend outlook post FY2020, the information given on allowed returns was negative.
“In our view, maintaining current dividend policies into the next regulatory review will be a challenge and the poor outlook for return-regulated equity is clear.”
Political risk
The Goldman analysts also said that, while they take no view on the likelihood of the Labour Party winning the next UK election, they note that its standing in the polls is on the rise.
They added that, with a manifesto pledge in the 2017 election, of taking the UK water sector into public control, they would “see significant risk for UK water sector share prices in the event that a UK Labour party victory was increasingly discounted by the market.”
The analysts continued that, in their view, this creates a deterrent to future M&A, which has long supported the sector.
In mid morning trading, Severn Trent shares were 0.5% lower at 2,001p, while Pennon also shed 0.5% at 723.6p, but United Utilities shares were up 0.5% at 744.2p.