Emma Wall: Hello and welcome to the Morningstar Series "Ask The Expert". I'm Emma Wall and I'm joined today by Morningstar Equity Analyst, Andy Bischof.
Hi Andy.
Andy Bischof: Hello.
Wall: So we are here today to talk about utilities that’s your special subject. What is special about investing in utilities?
Bischof: Well, in utilities you really have safety and I think you have safety of income and you have safety in terms of overall business structure, the regulated environment. And I think that’s what we have seen recently in the U.K. you've seen very strong run up in both United Utilities and SSE recently based on this kind of flight to safety amid political uncertainty.
Wall: And that’s key isn’t it, because safety and income are two things that U.K. investors are desperate to get, both because of Brexit and indeed because of the incredibly low interest rate environment that we've had for than seven years now. But because of that these stocks are looking toppy aren’t they? They are looking fair valued.
Bischof: So SSE (SSE) we see about 4% overvalue which in the world of utilities is actually pretty good. But United Utilities (UU.) on the other hand we see about 20% overvalued and United Utilities will probably see pretty low earnings growth over the next eight years or so.
Wall: But that doesn’t necessarily mean that they don’t have a place in people's portfolio. Because these stocks they do a special role don’t they and that is the income.
Bischof: Exactly. SSE you are going to get a nice 5.5% dividend yield. You have 40% of the business that is regulated so there is certainty in some of the earnings news there. Then you have United Utilities which is your very typical very solid regulated utility, water utility. So 100% regulated earnings, you have very clear outlook for the next eight years. So it might not be high upper digit percent you are still going to get very nice return and dividend return.
Wall: I suppose all that does sound a bit too good to be true. So what are the risks investing in these stocks.
Bischof: So historically you have to worry about regulatory uncertainty, will you continue to get that favorable treatment from regulators and you also have to worry about interest rates. Historically utilities have underperformed in a high interest rate environment.
Wall: And of course not a problem in such a low interest rate environment. But we won't stay like this forever.
Bischof: Exactly.
Wall: Andy thank you very much.
Bischof: Thank you.
Wall: This is Emma Wall from Morningstar. Thank you for watching.