Broker snap: Water stocks in 'sweet spot', says UBS

29th Jun 2012 10:03

UK water stocks - United Utilities, Pennon and Severn Trent - are in 'a sweet spot in current markets', according to UBS which says they provide safe returns and consistent outperformance."We believe that the UK water companies will remain in a sweet spot for as long as the current lacklustre macro environment persists, thanks to a limited risk profile, low UK sovereign gilt yield environment, and likely ongoing inflation support from quantitative easing," the broker said.UBS admits that low-beta water stocks would likely underperform if markets rally, but they still look "very attractive for those seeking absolute and/or inflation-protected returns, given the expected outperformance by all three listed water companies of their 4.5% post-tax real allowed return, plus a record 520 basis points spread of allowed real returns over 10-year real sovereign gilt yields."The broker said that merger and acquisition (M&A) activity is also possible "at some stage".UBS initiates coverage of United Utilities with a 'buy' rating and 725p target price (TP), saying that it expects a re-rating closer to peers "as the stock currently offers most of the attractions of the sector at a fraction of the valuation premium".With Severn Trent (1,695p TP) and Pennon (740p TP) trading at a premium ("deservedly") to United Utilities, UBS has started with a 'neutral' rating on both stocks given that their relative benefits outside of M&A are already priced in.BC