Global demand for power has soared, driven by spending on infrastructure in America and Asia – and Premier Utilities has benefited, with shares up more than 54% over one year.
The oil price is at an 11-month high, rising above $76 in trading last week. China has imported 20% more oil in the past 12 months than the same period just a year ago, and the International Energy Authority has raised its predictions for global power demand. No wonder Premier Utilities is sitting pretty. The £70m split-cap investment trust is one of the top performers over the past year of all investment trusts. Its ordinary shares are up 54.4% over one year and 205.2% over three years, although its zeroes are up just 8.2%.
Conventional investment theory tells you that utility shares are a near-bond proxy, bought for their dividends and regulated returns. It also tells you in a period of rising interest rates they should perform rather poorly, in the same way as a bond fund. It couldn’t be further from the truth. Utility shares (at least the ones carefully picked by fund manager Kevin Scutt) have been among the most attractive areas to be in over the past few years.
Scutt says: “The key drivers have been falling and low interest rates and low yields. But there have been other factors; the price of power was historically too low and had to rise. After years of margin pressure, margins are now good and improving. Meanwhile, spending on infrastructure has been rising, and not just in the UK.”
The trust has a global mandate, and has started to invest in emerging market plays. About half is invested in electricity generation and distribution – although that is slightly below the benchmark for the utility universe. The rest is in gas, water, telecoms and infrastructure.
The last two categories may surprise some investors in this sector. Infrastructure plays include stocks such as Autostrada in Italy while telecoms include Telefónica, which owns 02 in Britain. Is this stretching the definition of utility a bit? Not so, according to Scutt. “What we invest in are companies with resilient profits and stable earnings in what are often highly regulated markets. So that includes transport assets such as toll roads and ports, and fixed-line telecom operators.”
There are about 25-30 stocks in the portfolio at any one time, which makes it a rather concentrated portfolio, although it is difficult to classify utilities as high risk.
Scutt has analysed and managed utility stocks for two decades, including a 13-year stint at Hill Samuel and five years at Insight before joining Premier in 2005. He has trusted relationships with sell-side analysts in each region he invests, and takes a relatively quant-based approach to investing. The nature of utilities – their size and supervision by regulators – means it is less necessary to go out and kick the tyres in the way of other equity managers. “It is a fairly generic sector and you don’t have to see every management every quarter. But we do tend to get access if we need it.”
A decade ago, global utilities were seen as a mundane sub-sector, but Scutt says they have come to life over the past five years and now make a distinct investment category. But does that mean that new investors have already missed out on most of the action and can expect only dull returns, especially as interest rates are now rising?
“Utilities are believed to be interest-rate sensitive and when rates rise, they tend to fall. Indeed, in the UK they have fallen over the past few weeks by quite a bit. But if you look at utilities globally, then they have held up rather well.”
Scutt is rebalancing the portfolio away from Britain and continental Europe and towards Asia and America.
“We have 15% in China, investing purely through H shares traded in Hong Kong. Three of our stocks are power, the other is water, and they have performed extremely well.”
The biggest of his Chinese holdings is Datang (6.1% of the portfolio) which is China’s second largest power producer, owning four coal-fired plants and 28 power companies mostly in the Beijing area. As with everything in China, the numbers are boggling; Datang produced 20,000 MW of power last year, or about five times the output of Britain’s largest coal-fired power plant, Drax. Its shares have more than doubled from HK$5.15 to HK$12.30 (32p to 77p) in the past year, although some analysts now have it marked as a “sell”, given that it’s on a price/earning multiple of 22.
But Scutt is not worried about a slowdown in Chinese growth. “China built the equivalent of the UK power network in terms last year. But there is still a huge shortage despite all the new-build and a lot of catch-up to be done.”
It’s not all dirty power plants, though. Scutt has also bought into China New Energy, a renewables supplier, which in one day alone (and after Scutt bought in) went up by 30%.
The other region interesting Scutt is America. It’s in part a recognition that stock prices in Europe are looking rather toppy following a period of corporate activity. In contrast, American markets look fragmented and ripe for consolidation.
The problem for investors is picking stocks that are in growth markets – which Scutt says are Texas, the north east and California – and that can engage in corporate activity without running into state and federal issues.
He likes NRG, a power generator with interests in precisely those areas, and which has won the go-ahead for new nuclear power plants in Texas. Its shares are up 79% over the past year, and as the tenth largest generator (by revenue) in America could be suitable for takeover. Scutt has also started buying Williams Companies, a natural gas supply and distribution business that is the fourth largest power company in the country by revenue. Its shares are up from $24 a year ago to $33 in recent trading.
The trust is still on a discount despite the rises of recent years, although at 2% it’s not much. Given the likelihood of further energy price rises over the next few years (does anybody really think oil will fall back below $50-$60 a barrel?) then holding a small portion of an investor’s portfolio in income-producing utilities managed by the recognised expert in the field seems a reasonable bet.