What's the best power play?
As spin-off follows flotation, investors tempted by the generators will soon be faced with a wealth of choice
Sunday 30 June 1996
Power generation, a sub-group of the electricity sector, has taken a while longer. But its final shape became clearer last week after British Energy, the nuclear power generator, unveiled its prospectus. As well as marking the end of popular privatisation, British Energy will become the sole nuclear-only quoted generator in the world when it floats next month, valuing the business at about pounds 1.26bn. It leaves the generators a combined market capitalisation of pounds 14bn-plus.
The last piece of the puzzle should slot into place when Hanson spins off its energy assets, which will include Eastern Group, next January. Last week was also an important date for Eastern and PowerGen, when the former tied up a deal to lease 2,000 megawatts of generating capacity from PowerGen, at a cost of pounds 450m over a period of eight years. PowerGen said it lifts regulatory concerns from its business; earlier, National Power had sold 4,000MW to Eastern.
Hanson, which paid pounds 2.5bn for Eastern last year, is likely to net more than pounds 2.8bn. Energy investors will then have a choice from British Energy, National Power, PowerGen, Scottish Power, Scottish Hydro-Electric and Eastern Group.
British Energy presents special challenges in terms of valuation; its privatisation has sparked political uproar, while environmentalists are concerned at the consequences of allowing such a business to operate in the private sector. As a result, investors are once again being offered an array of incentives to climb aboard the privatisation gravy train.
The shares will probably yield more than 7.5 per cent, the rate of other electricity companies. Unusually, the prospectus suggested a range of 180p to 280p a share - far wider than in previous privatisations, and a sign of the difficulty the Government has had in determining its worth. The motto seems to have been: "Let the market decide." Put that with the part-paid nature of the offer, and investors are on to a potentially mouth-watering return, at least for year one.
The single most important factor for share prices of the generators in the medium term, however, is the outlook for electricity prices. Most analysts believe prices will fall, damaging profits. The UK gas bubble is one concern - plentiful supplies of cheap gas means a low cost of production. The gas effect is likely to be exacerbated in the short term, say analysts.
The fortunes of the electricity generation business are increasingly intertwined with gas - helped by the notorious "dash for gas" in the wake of the 1984 miners' strike. Combined cycle gas-turbine power stations now account for the bulk of the electricity generated in this country. A further blow to coal-fired stations came in a recent directive from Her Majesty's Inspectorate of Pollution. It imposed stringent new sulphur dioxide emission levels on coal-fired power stations. The improvements needed to bring remaining coal stations up to scratch will cost millions of pounds. So the increasing competitiveness of natural gas - which has low sulphur content - is expected to keep a cap on electricity prices for the next few years at least. Many believe the price can only decline.
Electricity prices in the UK are set by the pool, which has seen the number of bidders double from 10 to 20 in the last five years. Eastern, originally a regional electricity company (REC), has embarked on becoming an integrated energy company. As well as generation, it supplies electricity and gas.
The sector has also been engulfed by regulatory upheaval. Ian Lang, President of the Board of Trade, blocked National Power's bid for Southern Electric, and PowerGen's offer for Midland Electricity. He subsequently said the Government would exercise its golden share in the power generators to prevent any takeovers - which called a halt to the bid by Southern Company of the US for National Power.
Since then, shares in the two big generators have endured a stormy ride. Mr Lang's move leaves the sector at something of a disadvantage to other utilities, such as water and the RECs, where takeover froth props up the share prices of many companies.
British Energy will be a safe bet, at least in the short term. Labour seems disposed to handle the company with kid gloves, so regulatory interference should be minimal in the event of a Labour victory at the next election. But investors should be ready to take profits - it may prove a poor long- term investment.
Concerns over competition are probably overdone, and National Power and PowerGen are best placed to fight off the newcomers. Their efforts to diversify into complementary areas and to expand abroad also look set to pay off. Of the two, the best value seems to lie with PowerGen. It is smaller than National Power and the collapse in its shares has left it trading on a higher yield than National Power. Buy for the income and balance sheet strength - which can bring share buy-backs or further special dividends.
Share price 471p
Prospective p/e 9.1*
Gross dividend yield 5.3%
Year to March 31 1994 1995 1996 1997* 1998*
Turnover (pounds bn) 2.93 2.88 2.93 2.66 2.63
Pre-tax profits (pounds m) 476 545 687 604 642
Earnings per share 44p 49.6p 71.4p 60.2p 63.5p
Dividend per share 12.65p 15p 21p 24.25p 28p
* NatWest Securities forecasts
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