One way traffic in France's electricity invasion

The bulls return; Levy's challenge
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The Independent Online

The French invasion of the UK electricity market continues unabated. Yesterday, Electricité de France paid out a shade more than £1.7bn to add the wires business of Eastern Electricity and a Nottinghamshire coal-fired power station to its collection. London Electricity and Sweb were bagged by the French a long time ago.

TXU, the American owner of Eastern, says there was a healthy auction. But there was only ever going to be one winner. The business was worth more to EdF than anyone else because London and Eastern already operate their distribution networks jointly through the snappily named 24seven. And EdF could afford to pay more than anyone else, of course, because it is state-owned.

The TXU deal will leave EdF with 5 million customers in distribution, 3 million in supply and 10 per cent of the UK generating market, including the juice it imports through the cross-Channel interconnector. Nor is there any sign of the French stopping there. Even with London, Eastern and Sweb under its belt and a 75 per cent stake in Virgin Energy, EdF says it is still the poor relation of the UK electricity market compared with the likes of Innogy.

Stand by for more corporate action therefore. One further target for the French taxpayer might be Seeboard. This would give the French a clean sweep of the market from Norwich in the east to Bristol in the west and from Peterborough in the north to Brighton in the south.

The pace at which France's own domestic market is opening is, naturellement, proving a little slower. EdF has loosened its grip on a couple of French generating companies and agreed to auction off 6,000 megawatts of capacity to outside bidders. But its efforts still look puny compared with the revolution in competition that has overtaken the UK. When EdF first bought London Electricity back in 1997, the UK Government tried to use this as a pretext to wrest back authority for vetting the deal from Brussels. It failed and any attempt to use the argument again looks like meeting the same fate.

The bulls return

Is that really the raging herd we see before us, or is it just another illusion? The usual stock market definition of a bear market is a fall of 20 per cent from the peak. Well, since the FTSE 100 bottomed out on 21 September, the stock market has risen by just over 20 per cent, which would, presumably, mark it out as a bull market. The definitions are completely meaningless, of course, since a fall of 20 per cent from the peak is always going to be a whole lot more than a rally of 20 per cent from the bottom. On average, for instance, technology shares have doubled since the bottom, but they are still 75 per cent down on their peak.

Even so, stock market rallies don't come much sharper than the one we're witnessing now, and it's begun to make many believe the bear market is finally over. Could they be right? There's a good case to be made for it. Relative to bonds, equities have rarely been cheaper, in the last forty years at least. With interest rates so low, and the yield on equities even after the rally still in excess of 3 per cent, shares look good value. Dividends should grow over time. With bonds you are stuck with the interest rate you buy in at.

Bear markets cannot go on forever, and this one has already been a long one by historic standards. This looks like being the second year of negative equity returns. More revealing still, the FTSE 100 is now about the same level as it was on the way up nearly four years ago. Ignoring dividends, we've thus had four years of nil return on equities.

Admittedly the story on corporate earnings continues to look problematic, but with the earnings downgrades seen through September and October, expectations seem finally to be coming into line with reality. Then there's the view, hard though it may be to believe, that the macro-economic outlook is now actually better than it was immediately prior to the terrorist atrocities of 11 September because of all the policy action in the US and Europe taken since then.

So is now the time for the retail investor to pile back in again? As ever with stock markets, there's an equal and opposite counter view. Never mind the fact that we are still in the midst of a war, which although proceeding better than anyone dared hope, continues to be riddled with uncertainty and potential for serious international and economic damage. The real fly in the ointment is that although shares may look cheap against bonds, they continue to look expensive on many traditional valuation yardsticks, the most important of which is the earnings multiple.

The price/earnings ratio is the simplest way of valuing shares, and it is also still far and away the best. At present, UK equities trade at 19.5 times historic earnings, which is the sort of level traditionally associated with a strong period of growth in corporate earnings. As we know, earnings are in fact falling, and sharply too in most cases. To justify present valuations, then, you have to believe that the interest rate therapy will be working its magic by the early part of next year, and that there will be sharp and sustained rebound in earnings.

Not many businessmen would yet feel confident enough to predict such an outcome, despite all the action taken on costs in the last couple of months. The rally may have a bit further to run yet, but it would be unrealistic to expect the sort of double digit rates of return enjoyed in the past. One thing at least seems a reasonable bet. Sell bonds. Either equities are cheap or bonds are dear. It's not hard to figure out which of these alternatives is the more likely.

Levy's challenge

EMI warned in September of a first half loss, so yesterday's figures couldn't have come as a surprise to anyone. The unnerving thing was the warning of a possible fall in second half operating profits as well. Eric Nicoli, EMI's chairman, said that the aim of achieving a second half operating profit for EMI Recorded Music in line with last year wasn't yet unattainable, but the market had shown some further deterioration in the last two months. Even though the cost cutting programme seems to be proceeding faster than planned, Mr Nicoli is giving himself a ladder to climb down.

EMI has some special problems all of its own right now. In Latin America, where the company is disproportionately exposed, the market has collapsed, and in North America too there have been difficulties in making the group's various labels mesh as effectively as they should. But at root EMI's difficulty is the same as that of the whole industry – CD sales are falling and there are simply not enough exciting new acts around to return the industry to growth. The shift from vinyl to CD, for years a great motor of growth, is over.

Far from providing a renewed boost, the following generation of technological developments - mini-discs and internet downloads - have been deeply negative for an industry already suffering from the demographics of an ageing population. Music remains arguably the most glamourous industry in the world, but Alain Levy, EMI's new head of recorded music has quite a challenge in convincing the City the company deserves a correspondingly glamourous valuation.

j.warner@independent.co.uk

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