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Nationalisation – A look at the impact on water utilities

Nicholas Hyett looks at how one Labour policy could affect utilities shareholders.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

While the Labour Party has yet to announce its manifesto for this election, it seems likely nationalisations will feature. This could see major components of national infrastructure, such as water and energy utilities, rail companies and Royal Mail, taken back into state ownership.

Whether nationalisation is the right decision for society as a whole is a question for individual voters. But with over £19bn of shareholders’ money in the listed water groups alone, it’s a question many investors will have a particular interest in.

With that in mind we’ve taken a look at what nationalisation of the water utilities might look like and what it could mean for shareholders. This article is not personal advice. All investments can fall as well as rise in value, so investors can lose money. If you’re unsure of what to do, please seek advice.

What price for nationalisation?

In a conventional takeover, investors usually get a little sweetener on top of the current market value of their shares, called a premium. The same isn’t true of nationalisations, where the government can simply set a price. The Labour leader has already said there’s no guarantee shareholders would even get the prevailing market value for their investments.

But if a Labour government didn’t pay the market value, what could investors expect to receive in the event of nationalisation?

Firstly it’s worth noting that the most recent Labour Party policy on the issue made clear that investors wouldn’t receive cash in return for their shares. Instead they would be compensated with newly minted government bonds. But that still leaves the question of how many bonds they’d receive.

Pinning down exactly what the water sector is worth is difficult, partly because 12 of the 15 English water groups aren’t listed on the stock market. However, Labour has previously suggested the whole sector could be taken into national ownership for just £14.5bn. That figure was based on the industry’s cumulative book value, which is the difference between assets and liabilities. It’s also well below £44bn, the value of the sector’s equity according to a recent study by the Social Market Foundation.

A third option would be to acquire the assets for their Regulatory Capital Value (RCV). For the listed utilities this is still substantially lower than their current market capitalisations, so not an ideal scenario for shareholders either.

What is Regulatory Capital Value (RCV)?

RCV is a method for calculating the value of a utility company based on the total value of the capital assets. It is also used to calculate the returns that water utilities are allowed to make.

When looking at the table below, it’s worth remembering that around a third of Pennon’s profits come from non-regulated activities at Viridor, its waste management subsidiary. This likely wouldn’t be part of any nationalisation deal and goes some way to explaining why the percentage difference between Pennon’s market cap and RCV is so high.

Market Capitalisation * Book Value RCV minus debt
Pennon £4.8bn £1.7bn £1.4bn
Severn Trent £6.9bn £1.2bn £3.4bn
United Utilities £7.5bn £3.1bn £4.5bn

*Source: company annual reports, Thomson Reuters Eikon, as at 07/11/19

Is it all a bluff?

This all sounds pretty bleak for utilities investors.

However, while Jeremy Corbyn has said nationalisations could be below market value, that shouldn’t be a surprise. If the policy suggested nationalisations would take place at market price, the share price could rise and rise, and a Labour government would end up having to fork out more. Not great value for tax payers.

By threatening to pay below the market price, the Labour leadership keep share prices depressed, making an eventual nationalisation at market price more affordable. Of course there’s no guarantee nationalisations would eventually take place in line with market valuations, but threatening to undermine valuations is only sensible.

Betting on a bluff certainly feels risky though.

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Severn Trent share price, charts and how to trade

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United Utilities share price, charts and how to trade

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Article image: REUTERS / PETER NICHOLLS - stock.adobe.com.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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