Utilities: are they still a safe bet in an age of disruptive technology?

Income investors: for so long utilities have been seen as a haven for investors seeking income, but technology is disrupting every walk of life, and business. Are they still a haven?

Article updated: 16 July 2019 11:00am Author: Michael Baxter

Utility companies are typically known as defensive stocks. They operate in mature industries, with limited scope for dramatic innovation creating rapid growth, but the downside is limited too. For utilities, price elasticity of demand, or indeed income elasticity of demand, tends to be relatively inelastic. So, for example, if, due to some external shock, the price of energy shoots up, demand does not change much. If average income takes a knock, for example because of a recession, then once again, demand for energy barely flickers.

The last thing investors seeking an income want is volatility — so utilities seem to be the perfect fit.

Then again, share price performance is not always so good. Take Centrica, shares have almost halved in the last year and are down by around 72 per cent over the last five years. Dividends are at a tempting 11 per cent, (or so) but of course, a long term investor, who bought five years ago, would be receiving around three per cent — not so good. Centrica may operate in a mature industry, but it has massive debts, dividends exceed earnings and it has been losing customers.

The EDF share price has halved over the last five years, NPower has gained some ground over the last year, but lost around a quarter over the last five years.

I see an analogy with football. Some teams that are hoping to force a draw take an approach known as parking the bus: they push all their players back on to the goalmouth. But while some might call that a defensive strategy, it’s also risky, if the other team scores anyway, you have no chance.

And I wonder whether technology innovations will leave investors, who put too much into defensive stock, caught offside.

This video featuring Steve Jennings, Head of Power & Utilities UK at PwC illustrates my point.

Imagine a future, ten years from now, when the cost of energy storage has fallen sufficiently, such that we buy energy when it is windy or sunny, when electricity generated from wind turbines or solar is cheap, and store it in our home battery packs.

Renewable energy costs are falling. I first started to write about falling costs of renewables five years or so ago. At that time, renewable critics argued that the price falls were about to come to an end. They explained falls in solar generated electricity on dumping by the Chinese. Yet, in the last five-years, the cost of energy from solar has almost halved, from onshore wind it is down by over ten per cent and down by around a third from offshore wind.

Guess what? The cost of nuclear has gone up.

If these trends continue, our energy will largely be generated locally, the impact on traditional energy companies will be massive.

How they respond remains to be seen. But it seems to me, that in order to remain competitive, traditional energy companies need to think like startups. They need to apply an agile approach to product development and need to invest in R&D, the very activities which they famously don’t tend to do.

I am not saying avoid all utilities, but I am saying, that if you apply the ‘park the bus’ approach to investing, you leave yourself vulnerable.

Of course, there is one commodity we all need, even more than electricity, and that is water. Water utilities may not face quite the same levels of potential disruption as energy suppliers. Take Severn Water, shares are up over the last year and flattish over the last five — yield is quite appealing.

Of course, for investors wanting higher exposure to water, not just utilities, all kinds of opportunities emerge. I am not saying drown your portfolio in water, but if you want my idea for the commodity that will become a hot investment in an era of climate change, I see water, water, everywhere.

These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Michael Baxter portrait photo
Michael Baxter

Economics Commentator

Michael is an economics, investment and technology writer, known for his entertaining style. He has previously been a full-time investor, founder of a technology company which was floated on the NASDAQ, and a director of a PR company specialising in IT.

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