UK water companies rally as Citi, JPM optimistic on outlook

(Sharecast News) - UK water companies were on the rise on Tuesday as Citi and JPMorgan Cazenove struck a positive note on the outlook ahead of Ofwat's Final Determinations next month.

Citi said it expects a "constructive" set of FD proposals from Ofwat on 19 December, with improving returns, outcome delivery incentives risk reward balance and higher totex.

"Yet we struggle to turn more bullish beyond the FD catalyst despite unchallenging valuations," it said.

"While FD should provide much needed financial clarity for listed companies, pending government review of the wider water sector, balance sheet repairs and operational challenges will continue to drive share price volatility."

Citi upgraded United Utilities to 'buy', saying it was the best way to gain exposure ahead of the regulatory review.

The bank said it needs to see an operational turnaround in Pennon - which it kept at 'neutral' - and recapitalisation of its balance sheet before it can look to turn more constructive.

"We continue to flag Severn Trent (upgrade to 'neutral') premium rating versus the sector but see limited downside," it said.

Citi opened 90- day "positive catalyst watches" on United Utilities and Pennon into the Final Determinations.

JPMorgan Cazenove said it expects "significant" improvements in regulatory allowances on 19 December to drive a re-rating of the UK water sector, and it is turning more positive following its upgrade in June.

"We expect the Final Determinations (FDs) to de-risk the sector, justifying higher regulatory capital value premia compared to current valuations," it said.

JPM said it was refreshing its views for the next regulatory period, updating assumptions for future outperformance and growth.

"We see upside in our base case assumptions, which conservatively assume 50-70% less return on regulatory equity (RoRE) outperformance versus recent years, and 60% lower asset growth estimates than industry forecasts post-2030," it said.

"Incorporating estimates of RoRE outperformance more in line with recent history, and higher medium-term growth underpinned by statutory requirements, suggests a bull case for the sector implying 50-70% upside."

The bank placed all three water companies on "positive catalyst watch" into the FD.

JPM upgraded Severn Trent to 'overweight' from 'neutral', saying the premium to the sector is justified given its expectations of RCV growth and future outperformance, underpinned by the "best-in-class track record".

It also upgraded Pennon to 'overweight' from 'neutral' as it argued the market already discounts balance sheet and environmental performance headwinds the company faces.

"We acknowledge that a discount to peers is likely to persist until the market has clarity on the company's funding of capex to 2030," it said.

Citi maintained its 'overweight' rating on United Utilities, were it sees upside on conservative assumptions for outperformance in the next regulatory period, with upside risk to growth at FD.

At 1030 GMT, UU shares were up 3.4%, Pennon was 4.6% higher and SVT was 3.9% firmer.