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Secure inflation protection

Investors should take a look at a sector that is "better than gold"
April 18, 2013

The sudden lurch down in gold has spooked investors desperate for inflation protection, but regular readers of the Investors Chronicle would have benefited from our investment advice a little under a year ago when we highlighted a group of shares that are better than gold. We recommended investors should take a look at the solid gains and inflation-busting dividend income on offer in the utility sector, and with bid rumours once again swirling and share prices approaching record highs we thought it was worth revisiting the theme.

The investment case was simple: why hold something that produces no income, and has no use, when you can own a share in vital infrastructure assets that are structurally supported by the macro economic backdrop and generate inflation-beating dividend income. It seems we weren't alone in our thinking. In the period from 25 May to 16 April the FTSE All-Share utilities index has advanced 15.4 per cent to new highs, while the price of gold has fallen 12 per cent - an outperformance of some 27.4 per cent, and well ahead of FTSE 100 gains of 18 per cent.

 

 

But in today's febrile markets wired on cheap money things can change quickly. Luckily for holders of utilities, there has been little movement in the underlying tectonic plates of loose government monetary policy. Earlier this month, the Fed was making noises about continuing to buy bonds for the foreseeable future, and Mark Carney's arrival at the Bank of England is expected to bring growth targeting through more aggressive monetary policy. In Japan, a stimulus package that it is estimated will see some $1.4 trillion in Yen created has been launched to kick-start the economy of the most indebted country in the world. This is supportive of utilities for two reasons: borrowing costs are being kept artificially low by this intervention, which is important for the highly leveraged infrastructure groups, and with price increases linked by the regulator to the rate of inflation this should drive steady revenue growth.

Company nameTickerMarket Value £mNet Debt* £mPDIVIDEND YIELD %PE RatioPrice % Chg in 12 M
SEVERN TRENTSVT              4,171               4,055 17504.1419.58.97
UNITED UTILITIES GROUPUU.              5,036               5,323 738.54.4420.322.27
PENNON GROUPPNN              2,422               2,173 663.54.0813.8-9.17
CENTRICACNA             19,735               4,047 380.94.3114.119.78
DRAX GROUPDRXG              2,466  net cash 613.54.1211.813.82
SSESSE             14,648               7,054 15195.3513.511.86
NATIONAL GRIDNG.             28,956              20,400 7905.0412.521.54
Source: datastream * latest financial results

There are also company-specific reasons why utilities are still in favour. The energy sector was lit up when Centrica (CNA) signed a £650m deal to secure gas assets in Canada, further supporting the belief that gas will form a major part of our energy future and National Grid (NG.) has been on a strong run after it reached an agreement on its allowed returns for the next eight years with regulator Ofgem - it cleared up any lingering fears around dividend payments when it announced the dividend would continue to rise at least in line with inflation.

The water sector has attracted attention after perennial bid target United Utilities (UU.) hired Goldman Sachs in what was viewed by analysts as an attempt to bolster any bid defence. United Utilities remains a solid addition to any portfolio. Severn Trent (SVT), like many water sector peers, provided a reassuringly boring update for the period from November 2012 to 15 February 2013, with trading in line with expectations as declining water usage was offset by rising prices. Water utilities are also benefiting from cheap debt as Severn Trent showed when it raised £500m in January, its largest sterling bond ever, at a coupon of 3.625 per cent, which was five-and-a-half times subscribed.