Eastern is still exposed

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The Independent Online
Eastern Electricity is not given to hiding its light under a bushel. Announcing a 15 per cent rise in pre-tax profits to pounds 204m for last year, the largest of the regional electricity firms was yesterday keen to highlight the rapid growth in its non-core gas and power generation businesses. The implication is that Eastern will be much less exposed than the average electricity company to the clampdown on distribution prices expected to be announced by the regulator, Offer, next month.

If the company is to be believed, by the year 2000 about 40-45 per cent of operating profits will come from power generation and from the supply of gas and electricity - supply to the end user being a separate operation from distributing power over the wires. That would be a massive leap forward from the present situation, where electricity distribution accounts for about 80 per cent of profits.

Eastern is keen not to bill its expansion away from franchise operations as diversification, a term that can frighten investors. It prefers to call it "vertical integration" in electricity, alongside a "parallel" move into gas. But the key, says the company, is that growth is being driven by markets where it competes freely. It follows that these are markets where growth is not at the expense of captive consumers and where the long arm of the regulator cannot reach.

But regulation is likely to be the least of its worries. Eastern boasts that it is now the seventh-largest gas supplier in the land, with sales set to surge to pounds 200m this year from pounds 67m in the year just ended. The industrial and commercial gas market, however, is already becoming a bloody place to be, with competition likely to intensify further as regulatory restraints on British Gas are relaxed.

Similarly, it would be foolish to imagine that Eastern will find it easy to break off chunks of the power generation market, given rising competition there. Further out, it is not at all clear that the regional electricity firms will be allowed to continue with moves into power generation - recreating the type of structure that privatisation dismantled only a few years ago.

That leaves Eastern reliant on a regulated electricity business, dependent on distribution for much of its earnings, and exposed, like its peers, to a price review that is likely to be tough.

Underlying profits before exceptionals up 18 per cent to pounds 266m were ahead of some expectations, but the shares slumped 27p to 644p in line with the market. Eastern's prospects are probably rosier than most. A 5 per cent rise in earnings this year would put the shares on a prospective multiple of 8 and a massive discount to the market. But even that and a historic yield of 5.5 per cent reflect the risks of the regulatory review. Hold.