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Centrica and SSE feel the heat as UBS cuts price targets

Last updated: 07:38 06 Nov 2013 EST, First published: 08:38 06 Nov 2013 EST

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Analysts at UBS have declined to join in the utilities witch hunt, saying retail margins in the sector are reasonable at less than 5%.

If we carry on going the way we are, then UBS calculates UK household energy bills will have seen a rise of around 260% by 2020 from 2004’s levels.

Partly the rises are to make up for what UBS says is more than 15 years of underinvestment by the sector, but increasingly the fuel bill hikes can be attributed to governments having pursued environmentally-driven & socially-related energy policies over the last 10 years.

“With energy costs becoming an ever greater burden on domestic consumers, something has to give,” the team at UBS asserts, but in its view, retail margins is the wrong target.

“Even if retail margins were cut to zero, this would be more than offset by just a single year of (UBS forecast) rises in government & network charges. Also, we believe tariff freezes & other punitive measures could actually raise energy bills longer term,” UBS said in a research note on the UK utility companies.

UBS has identified policies that could cut retail tariffs to 2020 by around 5% in real terms.

“Options are available to governments to sustainably reduce the consumer burden by focusing on environmental and social costs, and on uses for government revenue derived from energy policy measures,” the Swiss bank argues.

However, it seems to concede that the Labour Party, if elected, is unlikely to listen to UBS and would instead stick to its announced policy of a tariff freeze.

According to UBS’s abacus rattlers, this would slice 13p off the valuation off Centrica (LON:CNA), which operates under the British Gas and Scottish Gas brands, and would lop 54p off SSE’s (LON:SSE) valuation.

Of the two, UBS prefers SSE to Centrica, as it believes the former is oversold compared to the latter when valuing the Labour freeze and possible follow-on policies.

“Although not riskless, we believe SSE remains attractive relative to Centrica and EU peers, and in absolute terms. We reiterate our Buy rating on SSE and our Neutral call on Centrica,” UBS announced.

“We now include in our forecasts the impact of a windfall tax on the carbon price floor benefit on old hydro and nuclear, to reflect this risk. Based on this and other updates, we trim our price target for SSE to 1,570p from 1,630p, and for Centrica to 355p from 370p.”

Both price targets are based on sum of the parts valuations.

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