Supportive environment for regulated utilities: Enagas our top pick
Regulated utilities’ dividend yields attractive vs. bond yields
For Spanish and Italian regulated utilities, spreads between dividend yields
and local bond yields are significantly above historical average levels and
in some cases close to peak levels. We believe this creates an opportunity,
as we expect a supportive macro backdrop for regulated utilities in 2016.
Little regulatory risk in 2016/17...
Following the approval of new regulation in Italy, there are no regulatory
reviews scheduled in Italy, Spain or the UK before 2018. We therefore see a
very high degree of visibility for EPS and DPS over the coming years.
...and stable European government bonds to be supportive
Regulated utilities’ share prices are inversely correlated to local
government bond yields. Our economists expect no change in Spanish/
Italian bond yields, with only a small increase in German/UK 10-year bond
yields (+30/40 bp over 2016). We see this environment as supportive
compared to commodity-exposed parts of the sector, although we remain
selective among regulated names. We are most positive in Spain, with Buy
ratings on Enagas and Red Electrica, along with Elia in Belgium.
Enagas (CL Buy) top pick among regulated utilities
Enagas is a Conviction List Buy with 29% upside potential. Spanish gas
regulation is fixed until 2020 and we see upside risks to Enagas’s dividends
(policy to be updated with FY results in February). Enagas’s dividend yield
is c.350 bp higher than Spanish 10-year government bond yields, vs. a
historical average spread of 160 bp. In the medium term, falling gas prices
could increase gas demand in Spain, enhancing Enagas’s earnings growth.
We see little risk that Enagas’s regulation is reviewed, regardless of the
eventual outcome of the Spanish election (as gas regulation was
comprehensively overhauled in 2012/13).
Snam to Neutral: Italian regulation more favourable than expected
The Italian energy regulator has updated regulation for 2016, with
incentives higher than we had previously expected. With greater regulatory
clarity we believe the Italian regulated utilities should be valued as “bond
proxies”, in the same way as we treat the UK and Spanish names. We
upgrade Snam to Neutral from Sell. Terna remains a Sell.