What Does Energy Freeze Mean for Utility Stocks?

The Labour Party's proposed freeze of gas prices could result in significant value impairment for UK utilities such as SSE, Centrica and National Grid

Charles Fishman 26 September, 2013 | 11:04AM
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In a surprise announcement, the UK’s Labour Party proposed freezing power and gas prices from 2015 to 2017, a move that could result in significant value impairment through lower investor returns for UK utilities such as SSE, Centrica, and National Grid. The proposal also would replace Ofgem with a more powerful regulatory body, potentially jeopardizing the constructive regulatory environment that supports our earnings and dividend growth forecasts for SSE and National Grid.

We think the proposal is unlikely to become policy in its current form and are reaffirming our fair value estimates for SSE ( SSE) (£16.70 per local share, $26 per ADR share), Centrica ( CNA) (£3.80 per share), and National Grid ( NG.) (£8 per local share, $60 per ADR share). We also are reaffirming our narrow moats and stable moat trends for all three utilities but would consider downgrading our moat trends if the proposal were to gain traction. SSE and Centrica would face the biggest impact because of their retail operations. National Grid likely would be less affected because it has no retail operations.

Ofgem's newly instituted eight-year rate cycle supports our forecast for £7.2 billion of generation and transmission investments in 2013-17 at SSE, and National Grid's recently approved plan to invest £20 billion in UK electric and gas infrastructure in 2013-21. The investment plans and regulatory structure support our 6% regulated asset value growth and 5% dividend growth forecasts for SSE and National Grid.

At Centrica, we estimate residential energy supply will contribute over 50% of British Gas’ operating profit in 2013, or about 20% of Centrica’s consolidated adjusted operating profit. If Centrica were to exit the retail energy supply business, an unlikely event in our opinion, our fair value estimate could decline to approximately £3.00 per share.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Centrica PLC123.00 GBX2.16Rating
National Grid PLC964.00 GBX-1.89Rating
SSE PLC1,710.00 GBX1.15Rating

About Author

Charles Fishman  Morningstar Equity Analyst, Equity and Credit Analysis

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