Broker snap: UBS downgrades United Utilities on regulatory risk

26th Apr 2013 11:38

UBS has downgraded its rating for United Utilities from 'buy' to 'neutral' on the back of its negative exposure to regulator change."We believe the UK water sub-sector remains attractive in the current macro environment, despite regulatory change and a likely cut to allowed returns," UBS said in a research report.Ofwat intends to set separate price controls for retail and wholesale services in the water industry, reviewing companies' individual business plans and assessing what they need to spend and invest to deliver services. This includes assessing how much it will cost the companies to borrow on financial markets."Even if allowed weighted average cost of capital (WACC) is cut by 50 basis points (bps) to 4.0% post-tax real, we calculate the sector should trade 1,300bps above its historical average of 3.0% to regulatory capital value (RCV), with valuations thus unlikely to fall substantially during the 2014 review."However, while the risk from regulatory changes is not excessive ("and less than the threat to allowed returns"), it will fall "most harshly on United Utilities" (UU). "UU's negative exposure to regulatory change is higher than its listed peers in both base- and worst-case scenarios, but it looks fairly valued at current levels. We see UU's dividend at risk of a -10%-plus rebasing post 2015. Upside risk through M&A remains a possibility, although unlikely, in our opinion."In the same report, the broker upgraded its rating for Pennon from 'neutral' to 'buy', saying that earnings from the group's water management business Viridor have troughed and the growth story remains intact.BC