Utility companies don’t always get the attention they deserve from investors. That might be because the profits they earn are limited by regulators. But as the world moves to a more sustainable future, there are opportunities for companies that get ahead of the curve.
Here’s a look at three businesses that are positioning themselves with the aim of benefitting from the transition.
This article isn’t personal advice. If you’re not sure if an investment is right for you seek advice. Investments and any income they produce can fall as well as rise in value so you could get back less than you invest. Past performance isn’t a guide to the future.
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National Grid – it’s electrifying
National Grid’s a vital business. It owns and operates essential energy infrastructure across the UK and north-east US.
As the energy landscape changes, National Grid’s attempting to plant itself at the centre of the electric revolution. It’s already sold several assets, meaning its portfolio is almost 70% weighted towards electricity.
The group’s not stopping there though. Around £29bn in spending is ear-marked for the decarbonisation of its energy networks for the period up to 2025/26.
In return for investing billions maintaining and upgrading its infrastructure, regulators allow National Grid to earn a reasonable profit, with the potential to earn more if it exceeds targets. That translates into more predictable revenues, which are expected to grow 4% to £19.1bn this year.
But the regulatory environment can be a double-edged sword. As the government prepares for the UK’s electric future, the group was forced to give up control of the networks it owns by separating the Electricity System Operator business. This serves as a reminder that the group’s fortunes aren’t completely under its own control.
National Grid will also need to invest heavily to prepare for an influx of connections as the drive for electrification accelerates. In the past, Ofgem has rewarded the investment with permission to improve profits, but the recent surge in energy costs means consumers are already struggling to pay their bills. That’s put a lot of pressure on regulators to start slicing into utilities’ profits which could put a brake on future growth.
Net income’s expected to rise from £2.2bn to £2.5bn when the group reports full-year results later this month. This feeds into what should be a relatively dependable dividend, with the shares on a prospective yield of 5.1%, one of the highest amongst UK listed utilities. As ever though, yields are variable and no dividend is ever guaranteed.
National Grid has the traditional pros of a utility, but with some growth opportunities mixed in there. We don’t think the valuation looks too demanding compared to its peers. But investors should be aware that the group’s fortunes are largely in the hands of regulators.
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NextEra Energy – size matters
NextEra Energy is an electric power and energy infrastructure company, based in the US. The group operates through two businesses.
The first, Florida Power & Light Company (FPL), is an electric utility. It generates and supplies power to more than 12 million people across Florida. Although a supplier to just one state, it’s the largest electricity supplier in the US.
FPL benefits from a constructive regulatory environment in Florida, which offers the potential for utilities to earn relatively high returns. Growth from here is being driven by continued investment, which is expected to grow capacity for the fastest-growing state in America.
The second is NextEra Energy Resources (NEER). Through its partnership model, whereby it joins forces with other companies, NEER has become the world’s largest generator of renewable energy from the wind and sun.
NEER was an early adopter of wind generation, building a competitive advantage by securing some of the country’s most desirable locations. It also had the foresight to lock in 20-year contracts with price escalation clauses, protecting future returns against inflation.
Together, the two businesses brought in $21bn in revenue last year. 2023 got off to a good start too, with underlying earnings growing 15.3% to $1.7bn in the first quarter.
But the group’s not without its problems.
There’s been allegations of improper political donations by FPL. After an internal review, management said it believes the company won’t be penalised. But the case remains open, and any negative developments would likely harm investor confidence.
Growth prospects are also reliant on continued government subsidies to help foot some of the bill. Although, improving economics surrounding renewables are slowly reducing this risk.
NextEra Energy offers investors the relative dependability of a large utility, with the inbuilt exposure to the growth potential of renewables. But these growth prospects are reflected in a valuation which is much more demanding compared to its peers.
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SSE – UK’s renewable giant
SSE’s networks deliver electricity across Scotland and Southern England. This is classic utility territory – with revenues and profits closely regulated. Regulated revenues and profits tend to be relatively predictable because prices are set in-line with wholesale costs.
The trade-off for this relative stability however is minimal growth. But that’s where the group’s pivot towards renewables comes in. It puts SSE in a position to potentially enjoy steeper growth in the years ahead. These efforts are being turbo-charged with record levels of investment – in excess of £2.5bn this year alone.
There’s also been good news for the bottom line. Full-year underlying earnings per share (EPS) guidance has been upgraded twice in recent months, from at least 120p per share to at least 160p per share.
But the shift to renewables comes with its own challenges. The main one is they’re not always reliable. To some degree, they’re at the mercy of mother nature. Unseasonably calm and dry weather last winter left the group’s renewable output lower than planned. Flexible gas-fired plants will now have to continue plugging the energy shortfall in the near term. Fortunately, these are part of SSE’s offering, and can help smooth out its revenue.
In a bid to free up cash for the renewables investment, the group plans to rebase the dividend from more than 85p, down to 60p, for this financial year. A stark reminder that dividends are variable and not guaranteed.
There’s a clear need for investment in renewables and networks, and we think SSE’s ahead of the pack in this regard. But the transition will be costly, and it’ll likely be a long road until renewables can generate cash more reliably. This adds a layer of risk in the near-to-medium term, meaning investors should expect volatility as SSE makes this transition.
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Unless otherwise stated, estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates aren’t a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.
This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information
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