European utilities stocks are down 11% since September as rising bond yields take the shine off a strong run for the sector in recent years.
Average dividend yields now stand at 5.4% and other valuation multiples have also fallen, leading UBS analyst Sam Arie to ask if the declines are now overdone.
Utilities have become the focal point of investor aversion to interest rate-sensitive stocks as yields in bond markets started to increase in recent months.
BOND BULL MARKET
A bull market in bonds over the past 35 years led investors to search for businesses with similarly predictable cash flows and utilities' stable earnings profile fit the bill, as well as consumer staples stocks like Unilever (ULVR).
Now both sectors are in the firing line as bond yields gained as much as 20 basis points in some European markets in the last one week. While this is a small move, it comes from a low base as some government bonds in Europe traded at negative yields earlier in the year.
'While bond markets remain volatile, we remain cautious,' writes Arie in a note published today.
'But we reiterate: (i) that the sector is starting to offer value at least on longer term comparisons; and (ii) we see the semi-regulated names as a safer way to play the current uncertainty. We would be shifting the balance towards Enel, SSE (SSE), Centrica (CNA), Dong Energy and EDP Renovaveis but staying neutral or underweight for now on regulated names.'
KEY STOCKS
Arie considers regulated names in the UK to include National Grid (NG.), Severn Trent (SVT), United Utilities (UU.) and Pennon (PNN).
Across Europe, UBS' regulated utilities sector has seen bigger declines than the rest of the group, down around 14%. Stocks in this industry segment still trade at valuation premiums of around 20% to their historical averages, Arie adds.
Semi-regulated utilities, Arie says, includes SSE in the UK. This part of the utilities industry is down 9% across Europe since the end of September when bond yields started to rise and now trade close to historical valuation multiples. Arie's preferred pick across Europe is Italy-headquartered multinational Enel.
Centrica is included in a 'commodity' sub-sector of the utilities industry and is another of the UBS analyst's preferred picks.
Today, utilities are outperforming the wider market in the UK, trading around 0.2% lower versus FTSE 100 declines of almost 1%.
