Bottom Line: Electricity surge will continue

MIDLANDS Electricity brought the regional electricity company reporting season to an appropriately upbeat conclusion yesterday with a 15.9 per cent increase in dividend.

While other companies, large or small, struggle to offer any increase at all, the RECs have lifted their payouts by an average of 15.2 per cent.

Offer, the industry regulator, is due to deliver its plans for the companies' higher-voltage 'supply' business on Friday. And it is about to embark on a review of pricing in their more important lower-voltage distribution activities, to take effect in 1995. Are the RECs tempting fate with their largesse to shareholders?

One line of defence is that Offer, unlike Ofwat, is more concerned with prices to customers than returns to shareholders.

This is why almost all the RECs have linked their dividend hikes to rebates on electricity bills, claiming that this 'shared' the benefits of efficiency gains between shareholders and customers. In reality, most cuts in bills reflect lower coal costs or a clawback of potential overcharging under Offer's pricing formulae.

What would happen if Offer were to turn nasty and impose severely negative pricing formulae on the companies' distribution business from 1995 onwards?

The comforting point here is that the RECs' financial position will be so strong by 1995 that it would take a very draconian pricing regime to dam the stream of rising dividends. Average dividend cover is almost three times compared with less than two for the stock market in general.

A combination of cuts in real operating costs of 2 to 3 per cent a year - an undemanding target to judge by the RECs' performance last year - and future benefits from lower coal costs ought to absorb the brunt of a tough pricing review. This means dividend cover is a good starting point for selecting electricity company shares.

Another is the ability to generate sizeable unregulated earnings streams. Forget retailing and contracting. Gas marketing, especially if the Monopolies and Mergers Commission turns on British Gas, and power generation offer much more scope.

But as dividend cover falls and larger and larger investments are made in initially dilutive, unregulated activities, the required yield on REC shares, now 5.1 per cent, may well have to rise relative to other shares.

This concern aside, any shortlist of RECs must include Norweb, Southern and Manweb.

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