LONDON (ShareCast) - (ShareCast News) - Eyeing significant undervaluation in the utilities sector, Investec slapped 'buy' recommendations on United Utilities, upgraded from 'sell', and Pennon from 'hold'.
Investec said it believed the recent history and potential direction of the sector, from an equity investor standpoint, can be explained by worries about falling real gilt yields, preferences for low risk income and concerns about regulation and liberalisation.

Each of these three macro-dynamics are subject to two-way risks, the bank said.

"While the narrative of 'normalisation' is entrenched in the consensus view, we believe there remains long-term value to be found based on secular fundamentals. We consider recent cuts to allowed regulatory returns and the potential for financial and operational outperformance, and find there remains scope for earnings growth over the current regulatory periods," analysts wrote.

Pennon, United, plus fellow regulated players Severn Trent and National Grid offer scope for "considerable" outperformance of regulatory allowances, though NG's financial outperformance may fall substantially by 2019 under its reducing indexed cost of debt allowance.

Four-year forward average returns on regulatory equity indicate Pennon and United Utilities are "potentially undervalued versus peers", while the market it "substantially undervaluing" the scope for special dividends at both.

United Utilities is given a target price of 1,000p, Pennon 920p, with Severn Trent at 2,220p and National Grid at 1,030p both kept on 'hold' ratings.

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