LONDON (ShareCast) - Bernstein downgraded Severn Trent and United Utilities to 'market perform' from 'outperform', cutting the price targets to 2,150p from 2,300p and 1,040p from 1,050p, respectively.
"In our view the current valuations reflect a significant probability of takeover and we see limited upside to the current price in the near-term, unless there is an immediate take-out at a significant premium to regulated asset value," said Bernstein.
It noted that Severn and United have outperformed the sector over the past year, generating total shareholder returns of 13%, compared with the European Stoxx 600 utilities index at 4%.
Key drivers of the outperformance included a positive final outcome to the 2014 price review, with both companies confirming dividend growth at least in line with inflation over the next 5 years and a supportive UK election outcome which has reduced political risks, said Bernstein.
Bernstein said M&A is a key upside risk, particularly for United Utilities.
"We expect there to be interest in taking SVT and/or UU private due to the attractive underlying nature of the assets," said Bernstein, pointing to a stable regulatory environment, predictable cash flows, inflation hedging, duration matching, diversification from investment in equities and attractive income yields.
It added that with only three large pure-play listed regulated water-only utilities in England and Wales, Severn and United are scarce assets.
At 1008 BST, Severn Trent was down 0.3% at 2,141p and United Utilities was off 0.3% at 964.50p.
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