Take profits in Severn Trent, says Bernstein, or don't says Cazenove

There were differing opinions among analyst over UK utilities on Friday, with water company Severn Trent in particular downgraded by Bernstein and recommended by JPMorgan Cazenove.

Bernstein downgraded Severn Trent to 'underperform' from 'market perform', suggesting investors take profits due to strengthening regulatory headwinds. This has seen the shares fall more than 2% this morning.

The broker noted that regulator Ofwat has suggested companies' ability to pay dividends should be restricted to 5% of the equity regulatory capital value, which would be bad news for dividends at Severn Trent and United Utilities.

Even putting the cap to one side, Bernstein believes the lower weighted average cost of capital alone will drive dividend reductions for both companies in the next regulatory period: around 7% for SVT and 5% for UU.

The "tail risk" scenario of nationalisation under a Labour government has not been factored into Bernstein's valuation "but implies scope for material downside".

JPMorgan Cazenove on the other hand said it "generally" sees value in UK utilities and is upbeat on UK water’s prospects in the coming months as it sees a "clear run through to the end of the year", outside the publication of five-year business plans and financial results. It reiterated 'overweight' recommendations for SVT, United Utilities and Pennon.

But Caz is "relatively cautious" on energy, with Ofgem set to hand down key decisions impacting retail margins such as price cap policy consultation due later this month, plus the RIIO-2 framework consultation due in July.

National Grid remains 'overweight' and Centrica and SSE remain 'neutral' based on valuation grounds, "but for all three, the coming months might see more attractive entry points arising as clarity emerges on the regulatory front".