Institutional investors around the world are pulling their money out of utilities in favour of higher-risk equity investments, creating a potential contrarian investment opportunity, according to the latest BofA Merrill Lynch survey of fund managers.
As of February, the utilities sector was the least loved sector in all major regions, including Europe, the U.S., Japan and emerging markets, according to the survey results. “Utilities as an asset are roundly disliked by everyone ... it’s rare to see a single sector so disliked across the whole globe,” said Gary Baker, European equity strategist at BofA Merrill Lynch.
This move away from utilities indicates institutional investors are willing to take on more risk as recent economic indicators paint a rosier view of the global economy.
However, even though utilities are not as popular as they once were during the depths of the global recession, they may still be worth considering if you are concerned about prospects for a global economic recovery.
“If you believe Europe is going to fall apart and interest rates are going to stay low for the next three years, then [regulated utilities are] a good place to put your money right now,” said Morningstar utilities analyst, Travis Miller. However, Miller points out that investors should be aware that companies in the regulated utilities sector are not trading at bargain prices. Many regulated utilities shares are trading near Morningstar’s fair value estimates.
Regulated Utilities: National Grid, Westar Energy and PG&E
For example, the U.K.’s National Grid (NG.) may be a suitable option for those who are predicting continued economic doom and gloom. This company operates in a government-regulated environment which means revenue is generally stable and predictable. The utility company is also the only European utility to be singled out as a favourite investment opportunity amongst Morningstar analysts covering the sector. A recent Morningstar research report said: “With a 6% dividend yield and top-tier growth prospects, we think National Grid offers one of the most attractive total-return packages in the sector.”
However, before clicking the “buy” button, it’s important to note that shares in National Grid have rallied strongly this year, and the company is now trading near its fair value, said Miller.
Other utilities that operate in a regulated environment include U.S.-based Westar Energy (WR) and PG&E (PCG).
Deregulated Utilities: Centrica & Exelon
Meanwhile, not all utilities operate in a regulated environment. Many others operate in a deregulated environment, which exposes investors to more risk, said Miller.
Amongst Miller’s favourite deregulated utilities is Centrica (CNA). Morningstar believes the U.K.-based utility is undervalued, especially since shares in the company have fallen by roughly 15% in the last year. Miller estimates the company is worth 25% more than the current market value. “Centrica's market-leading positions should ensure solid returns for investors for many years regardless of commodity price movements,” reports Miller in his latest research.
The U.S.-based nuclear power company Exelon (EXC) also operates in a deregulated environment. The current Morningstar valuation indicates Exelon has been severely undervalued by the market, implying that now may be a good time to buy. “Exelon’s ability to produce low-cost electricity with minimal greenhouse gas emissions should produce substantial, sustainable, and growing shareholder value for many years, regardless of what path power prices take,” reports Miller in his latest research report.
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