Company Reports

European utilities have reversed their outperformance in the fourth quarter of 2023 because of a fall in wholesale power prices in the wake of gas prices after a very mild winter, and a pickup in interest rates due to inflation receding more slowly than expected. The former led to some of the companies, most exposed to power prices, cutting their guidance for 2024.

European utilities are up by 14% year to date, slightly underperforming the broader European markets. Since the end of September, the sector strongly outperformed thanks to the rally in government bonds and solid third-quarter results that drove multiple guidance upgrades although growth slowed down from the second quarter due to higher comps. All in all, companies that are the most exposed to commodity prices are set to exceed their 2022 record profits in 2023. Meanwhile, firms with big retail businesses that were hit by a margin squeeze because of the energy crisis in 2022 will post a significant rebound in earnings.

We confirm our GBX 1,040 fair value estimate after National Grid released fiscal 2024 first-half results in line with the company-compiled consensus, confirmed its fiscal 2024 guidance, and upped its investments through fiscal 2026. We forecast a fiscal 2024 dividend of GBX 58, implying a 6% yield, appealing for a dividend aristocrat and reflecting the undervaluation of the shares.

RWE and National Grid's joint-venture, Community Ocean Wind (73% owned by the former), was awarded a 1.3 gigawatt offshore wind project at the latest New York auctions. We reckon that the project's returns are above our estimates for offshore wind farms to be commissioned beyond 2030. However, Orsted's woes have shown that execution risk is high in the U.S. All in all, we confirm our fair value estimates of EUR 55 and GBX 1,040 for RWE and National Grid, respectively. The former is materially undervalued.

European utilities have underperformed the European market by 4% year to date with most of the underperformance occurring in the third quarter because of the rise in interest rates. This overshadowed strong second-quarter results driven by the easing of the energy crisis, persisting commodity price volatility, and the hedging improvement. These drivers have persisted in the third quarter. Moreover, some power price clawbacks expired at the end of June like in Germany and Belgium. On the flip side, the comparison basis will be tougher as of the third quarter.

National Grid owns and operates energy networks in the United States and the United Kingdom.

We don't plan to materially change our GBX 1,040 fair value estimate after no-moat National Grid released fiscal 2023 earnings in line with the consensus it polled and guided for a slight EPS slide in fiscal 2024 because of a regulatory change that has no cash flow impact. The firm will pay a fiscal 2023 dividend of GBX 55.44, 8.8% above fiscal 2022, in line with the policy to increase the dividend in line with inflation and implying a 4.9% yield, above the 4.2% sector average. Nonetheless, the shares appear a bit overvalued.

We maintain our GBX 850 fair value estimate after no-moat United Utilities confirmed its fiscal 2023 guidance in a trading statement. Fiscal 2023 results will be released on May 25. The 2023 dividend yield is 4.4% and the company pledges to grow the dividend in line with inflation through fiscal 2025. However, we view the shares as materially overvalued. For income-seekers interested in regulated utilities, we recommend National Grid, which yields 4.6%, pledges to grow its dividend in line with inflation through fiscal 2026, and whose shares appear fairly valued.

National Grid owns and operates energy networks in the United States and the United Kingdom.

We maintain our GBX 1,040 fair value estimate after no-moat National Grid released first-half results slightly above consensus it polled, upped its fiscal 2023 guidance, and its medium-term earnings guidance along with investments. The group confirmed its policy to grow the dividend in line with inflation. The shares look fairly valued.

Because of the market downturn and brutal selloff of United Kingdom gilts since August, shares of no-moat National Grid are down by 14% year to date, in line with the median of our sector average. Therefore, shares are now in 4-star territory for the first time since 2018. Our fair value estimate of GBX 1,040 involves a price/fair value of 0.89.

National Grid owns and operates energy networks in the United States and the United Kingdom.

We maintain our fair value estimate of GBX 950 after no-moat National Grid released a good set of fiscal-year 2022 results, set 2023 guidance in line with expectations, reiterated its medium-term guidance, and recommended a final dividend of GBX 51, 3.7% above last year and implying a 4.1% yield. Defensiveness of its business model and protection against inflation are appealing in the current environment but are more than priced in as evidenced by a forward P/E of 19 times.

No-moat National Grid has upped its fiscal 2022 guidance, saying that underlying EPS growth should be modestly higher than the "significantly ahead" of 5%-7% that it forecast at half-year results last November. Key to that is high inflation, as revenue of the U.K. electricity networks is indexed. Otherwise, the company said the underlying operating profit of its U.S. networks and National Grid Ventures is in line with previous guidance. On the downside, the fiscal 2022 underlying tax rate will be around 25% because of an additional tax charge related to the impact of upcoming tax rate hikes on the deferred tax liabilities. All said, we expect to tweak upward our profitability estimates for the U.K. networks on inflation in the short term, but the impact on our long-term estimates and valuation will be limited, so we maintain our GBX 950 fair value estimate. The indexation of U.K. networks revenue and the dividend is an enviable feature in the current inflationary environment. However, this is more than priced in with a 2022 price/earnings of 19.8.

We tweak our fair value estimate to GBX 950 from GBX 920 per share after no-moat National Grid announced the sale of 60% of its U.K. gas transmission assets to a consortium formed by Macquarie and British Columbia Investment Management Corporation at a price above our estimate. This should enable the company to avoid a dividend cut, unlike what we expected. That said, the tepid share price reaction shows that the high premium was largely priced in. The transaction is expected to be completed in the second half of calendar year 2022 upon clearing from the antitrust, in line with previous guidance. Shares appear overvalued.

National Grid owns and operates energy networks in the United States and the United Kingdom.

National Grid owns and operates energy networks in the United States and the United Kingdom.

We don't expect to materially change our GBX 850 fair value estimate after no-moat National Grid released first-half results above consensus it polled, raised its fiscal 2022 guidance, and maintained its medium-term guidance. The shares look overvalued.

We maintain our fair value estimate of GBX 850 per share along with our no moat rating after National Grid stated on Oct. 18 that trading is in line with expectations, ahead of the release of its fiscal half-year results due on Nov. 18. The current dividend yield is 5.4%, above the 4.5% sector average. However, we expect the dividend to be cut by 20% in fiscal 2024 to avoid a credit downgrade, which would put the company at the lower end of the investment-grade spectrum. All said, we see the shares as overvalued.

The wave of dividend cuts and cancellations from European utilities in spring 2020 in the wake of the coronavirus pandemic reminded investors about the lack of reliability of the sector's payout in challenging times. The current trailing median dividend yield of 4.4% is slightly below the 4.7% historical one but attractive against current government bond yields and provides some margin of safety should they rise. On average, we foresee a 4.1% dividend CAGR through 2025 largely covered by an EPS CAGR of 6.5%. However, the backdrop is mixed: we expect some companies to continue growing their dividends and other firms to cut them. This is the reason we classify the European utilities we cover into three groups.