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Broker snap: Water companies ripe for takeover

Now that the haggling with the regulator over price controls is out of the way Royal Bank of Scotland has been poring over the numbers for the water sector and concludes that there is value to be had.

'We conclude that the sector looks cheap. We estimate that UU [United Utilities] and Severn Trent are trading below RAB [regulatory asset base]. while dividend policies are clear and further M&A [mergers & acquisitions activity] is possible,' analyst Ian Turner said in a note initiating RBS's coverage of the water sector.

Turner said that price control by water regulator Ofwat was 'tougher than was hoped for' but 'efficiency targets have been relaxed between draft and final proposals and investment over the next five years will be £22bn for the whole industry, about 7% higher than the spend in 2005-10.'

Predatory activity is not unknown in the sector and with, by RBS's calculations, most players trading below or marginally above their regulatory asset base valuations there is scope for more consolidation. RBS doubts, however, that take-out prices will be at a 30% premium to RAB that have been seen in the past.

'We are initiating coverage of the UK water sector with a Hold rating on Pennon (price target 570p) which trades at small premium to its RAB, on our estimates. We have Buy ratings on Northumbrian (price target 310p), Severn Trent (price target 1,500p) and United Utilities (price target 680p). We estimate that the latter two trade at small discounts to their RABs,' Turner concludes.

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