‘Nationalisation’ is a word that generally causes investors in utility stocks to feel somewhat uneasy. After all, if it takes place then it would be likely to mean a period of significant difficulty for investors in utility shares. And, with the policy and the Labour Party becoming increasingly popular in the last few years, the chances of it taking place appear to have increased.
However, the market seems to have factored in the potential risk of a change in government policy. High yields are on offer throughout the sector, and this could make companies such as SSE (LON:SSE) and National Grid (LON:NG) appealing even though they may also face increasing regulatory risks.
The likelihood of nationalisation
Perhaps what is most worrying for investors in utility shares is that the British public is hugely in favour of nationalisation. For example, a recent poll stated that 77% of people are in favour of nationalising electricity and gas companies.
The Labour Party has already stated that it plans to nationalise a number of different industries should it win the next election. While the 2017 election resulted in a hung parliament, the chances of a Labour win next time around seem unlikely at the moment. Polls since the start of April suggest they would fail to gain a majority if an election is held in the near future.
Clearly, a lot can change between now and the next election. Progress on Brexit could have a significant impact on the public’s mindset. But at the moment, nationalisation seems to be a risk that could also present an opportunity for investors to reap high income returns over the medium term.
SSE and National Grid offer dividend yields of 7% and 5.5% respectively. Both of these figures are high relative to their historic figures, and this suggests that the market may have priced in their risks.
Dividend growth prospects for both companies appear to be encouraging. SSE plans to match RPI inflation in the current electricity distribution price control period (which ends in 2023). During that time, it plans to demerge its UK household energy supply and services business. This is due to take place in late 2018/early 2019 and will see its shareholders receive one share in the new entity for every share they hold in SSE.
SSE, of course, faces regulatory risks in addition to the potential for nationalisation. For example, energy price caps are expected to be in place by the end of 2018 for standard variable tariffs. They could cause profitability to come under pressure, with a further loss of customers also seeming likely in the near term.
National Grid aims to grow dividends by RPI each year for the foreseeable future. It faces regulatory risk from Ofgem’s efforts to limit its profits from 2021, with there being the potential for a reduction in its baseline cost of equity. However, with the company continuing to invest heavily in the US, the impact of regulatory change in the UK may not be as significant as the market is currently pricing in.
Therefore, while the two companies face regulatory risk, as well as the threat of nationalisation, their income potential still seems to be high. They appear to offer margins of safety, as well as inflation-matching dividend growth potential over the next few years.