The Investment Column: Utilities offer relief from oil jitters

Turbo Genset lacks performance power
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The Independent Online

The economic havoc that could be wreaked by the soaraway oil price of recent weeks is just the latest in a long line of reasons to invest in the UK's utility companies.

The economic havoc that could be wreaked by the soaraway oil price of recent weeks is just the latest in a long line of reasons to invest in the UK's utility companies.

These are the "defensive" companies whose wares - water and electricity - are the staples of modern life, and where demand does not ebb and flow with the economic tide. The equity markets began adjusting back in the spring to the idea that economic growth is not going to be as fast next year as this, and defensive stocks have been in increasing demand. The utilities sector is up 12 per cent this year, compared with a 2 per cent fall by the FTSE All-Share.

And both the water and electricity industry have enjoyed favourable reviews by the regulators, which tightly control customer prices and companies' investment plans. Water shares, in particular, have had a great run since 5 August when Ofwat published draft proposals for the next five-year regime. This is the proposal that included the headline-grabbing ruling that water bills will rise 13 per cent by 2010, with a big early increase next year.

The water industry is being allowed the money to help fund £16bn of improvements to the nation's sewers and other water infrastructure, and the companies that can make these improvements most efficiently and cut most costs in their day-to-day operations will be the ones with the most cash to hand back to shareholders.

So who might those winners be? Probably not Northumbrian Water, which got less of what it asked for from Ofwat than many rivals. This newly listed company is burdened with more debt than the average and its shares, although cheap, are a buy for the brave only. The dividend yield at AWG is high because it is the one most at risk, and the regulator is demanding very tough operating efficiencies which it might not meet.

The trick for income investors is to find not just the stocks with the highest dividend yield in the coming year but those with the best prospects for expanding the payout quickly in the coming years. The more efficient operators, like Severn Trent and Pennon look to have the most appealing mix of a cheap share price and likely dividend growth.

Northern England's United Utilities, which straddles the water and electricity sectors (water accounts for 80 per cent of its assets), has much reduced prospects for dividend growth compared with rivals but is worth holding for the already huge yield and the balance sheet strength afforded by its £1bn two-stage rights issue.

In electricity, we would be buyers of both Scottish & Southern Energy and ScottishPower, the former for its the security of its dividend, the latter for growth prospects in the US power market.

International Power's recent buying spree of international power generation assets has gained it a better reception in the City than for some years, but without a dividend it still looks an unappealing beast. But National Grid Transco, the gas and electricity networks business, ought to outperform as it sells off its unwanted local gas pipes. And pick of the utilities sector continues to be Centrica which, after the sale of the AA, has enough cash pouring in from its British Gas business to pay for new power generation and storage assets and generous returns to shareholders.

Turbo Genset lacks performance power

Turbo Genset was briefly a stock-market wonder-stock. At the tail-end of the tech investment boom, and as the US was in the throes of the California energy crisis, it seemed to offer the hope of a new "mobile power generator" that would allow businesses to become self-reliant, generating their power on-site and be environmentally friendly at the same time.

Not yet it doesn't. It has taken longer than expected to develop the kit, with Turbo Genset having to unravel co-development arrangements with other, bigger engineers who were less enthusiastic. Now it does more of the work, but is struggling to find a commercially viable product that might, one day, take the world by storm. What we did have yesterday was the first commercial sale of a 1.2MW generator, to a US landfill company. Methane from one landfill site is being used to power the generator, which is "green" because it harnesses the heat that normally escapes from a generator and converts it into yet more power.

It is a milestone, an important one, and Turbo Genset shares rose 0.25p to 16.75p, but it should not obscure some important facts. First, although a commercial sale, this is more akin to a pilot project, since Turbo Genset has to demonstrate it works before it gets follow-on orders for the kit which the customer might want to use at other landfill sites. Secondly, other much talked about deals to sell generators to Indian hotels or a UK water company are yet to be fulfilled.

And thirdly, loss-making Turbo Genset is on course to run out of money by this time next year. The company has so exhausted the patience of stock market investors that it will have to look to other sources. We advised waiting when the shares were 42.5p a year ago, and the wait for a positive return may be some time longer.