RBC downgrades Pennon, Severn Trent on regulatory fears

26th Nov 2018 14:43

(Sharecast News) - Analysts at RBC Capital Markets downgraded Pennon on Monday on the belief that the water and waste group will have a difficult time outperforming many of its peers.RBC believes Pennon represented "a good mix of regulated and non-regulated cash flows", but cut its target price on the group from 925p to 800p and so moved its rating to 'sector perform' from it previous 'outperform'.Analysts at the Canadian investment bank highlighted risks such as material changes to the regulatory framework within the water industry, an unexpected deterioration in credit metrics, unfavourable retail price index changes and rising long-term interest rates as becoming potential impediments to its target price.Operating South West Water and recycling business Vridor, Pennon's valuation could also be hit by changes to EU/UK waste legislation post-Brexit.In terms of the financials, RBC forecast real RPI-based return on regulated equity to be around 5.0% in the AMP7 regulatory period versus 10.4% in AMP6. "The reduction from our previous estimate of 5.8% reflects lower assumed financing and [total expenditure] outperformance as tougher benchmarks restrict PNN's ability to outperform relative to its listed peers."Severn Trent was also downgraded, but only from 'top pick' to 'outperform' and still remains the analysts' preferred stock in the water sector "as we believe that there is strong upside to our current numbers as a result of further outperformance through ODIs, which we currently give no value to in AMP7".However, in line with Pennon and United Utilities, RBC curb its view on Severn Trent's outperformance post-AMP6 and moved its price target to 2,250p per share from 2,650p and removing the stock from its European large cap best ideas list.On United, the dividend remained "sustainable", but compared to rivals, this name is seen as "the most disadvantaged by Ofwat's current framework and we do not expect the playing field to level overnight"."However, UU appears to be significantly undervalued and a strong 'value play' for investors due to unjustified perceived risks on its dividends."UU was kept on an 'outperform' rating but its price target trimmed to 950p from 1,050p.