Should you invest in ... utilities?

UTILITY STOCKS have been an important part of many private investors' portfolios for a decade or more, since the attractively priced privatisations of the late Eighties and early Nineties. Their yields have traditionally been high and share price growth has also been good, not least because of the level of merger and takeover activity in the sector.

More recently, performance has been less impressive, with the three main types of utility - electricity, water and gas - underperforming relative to the telecoms companies, no longer really regarded as utilities.

David Harbige of Barclays Stockbrokers says: "You might have thought utilities would benefit from that, but the problem is that utilities are seen as defensive and when the economy shows signs of picking up, investors do not want to buy defensive stocks."

Tony Mather of Edinburgh Fund Managers agrees. "People will look at bond yields and look at the regulatory issues and these will have been dampening factors. Since January we have seen a contest between growth and value stocks and defensives are on the sidelines."

As for the different types of utility company, David Harbige says: "We like water and electricity and we would buy both at current levels. But we think gas has gone far enough."

Taking the electricity companies first, Simon Melluish, manager of the Gartmore Utilities Fund, says: "The UK and European electrical utility companies have had a bad period in relative performance. In the UK, there are rumblings of increased regulation in terms of changes to the pool pricing, which has been a dampener on the electricity stocks".

Tony Mather adds: "The electricity distribution review is to be completed by mid-November, so we will know what is happening then. But the old- style, predominant generators are now being forced to diversify, in response to the different trading conditions to be imposed over the next year or so."

John Hildebrand, of Investec Guinness Flight, plumps for companies that can generate cash. "We like things like National Grid, which will not have too much regulation. It will also be able to give money back to shareholders and it can realise its stake in Energis to release capital. Also British Energy has been hit hard and we think it is oversold. Producers will come under continued pressure, but British Energy produces such a large cashflow that it looks quite a cheap share."

He is less keen on National Power. "The management has performed poorly and its overseas investments have not worked." But David Harbige is more positive on the long-term prospects for National Power. He says: "NP was in talks with United Utilities and it is ultimately likely to be split up, leaving a highly cash-generative UK business and an overseas part with unregulated businesses that offer better growth prospects. We reckon its break-up value would be 550p per share (currently 465p)."

Damian Larkin, of stockbrokers The Share Centre, likes Scottish Power, because of its business mix. "It has good management and a defensive earnings profile, with more exciting investments like Scottish Telecom and Demon Internet in its underlying portfolio."

Tony Mather says: "The Ofwat statement is due on 27 July, and this will indicate how hard it will hit water prices. This will have a considerable impact, because the review covers prices for five years."

David Harbige says: "United Utilities is a well-run business with a spread of activities, involved in water and electricity, with a small phone business."

John Hildebrand, too, is positive about water stocks. "Now is the right time to buy, though the sector will still probably perform poorly in the short term."

Simon Melluish adds: "The market has been impressed by Centrica and BG returning cash to shareholders, either in dividends or by other means."