RBC Capital Markets reiterated its positive view on UK regulated utilities, saying the group benefits from clear visibility on future cash flows and relatively low regulatory risk. The brokerage underscored that inflation can act as a tailwind under the prevailing regulatory structures, boosting indexed asset bases and supporting cash flow uplift.
The firm kept its rating of "outperform" on Pennon Group with a 650p price target and on SSE with a 3,025p price target. National Grid and Severn Trent were left at "sector perform." RBC identified Pennon and SSE as its preferred names within the sector.
On water, RBC maintained Pennon as its preferred pick, pointing to what it described as a yield advantage of more than 100 basis points relative to peers and an expectation that Pennon will deliver compound annual earnings per share growth of roughly 10% through fiscal 2031. The brokerage also noted that Pennon is trading at about an 8% premium to its fiscal 2027 regulated asset base, which it contrasted with higher premiums seen among other peers.
In the networks space, RBC highlighted that SSE and National Grid are set to show the strongest asset growth. The brokerage put five-year compound annual growth in regulated asset base at about 23% for SSE and about 12% for National Grid. It expects earnings growth of around 10% annually for SSE, Pennon and National Grid, with Severn Trent projected to see roughly 8% annual earnings growth.
RBC said the inflation-linkage built into regulatory frameworks is a constructive feature for cash generation, stating that inflation is "a net positive for UK regulated utilities given the real return structure and uplift in cash flows that comes from the indexation of the asset base." The brokerage said forthcoming regulatory milestones will provide additional clarity on sector arrangements, naming the PR29 review and a transition report that is expected after May elections as developments to watch.
With respect to PR29, RBC anticipates the review will likely incorporate elements from the Cunliffe Review, including modifications to returns and incentive structures. The brokerage noted, however, that more structural changes - such as the introduction of regional planning mechanisms - could require a longer timetable to develop and implement.
RBC also flagged the potential for additional capital expenditure to be approved through regulatory "re-openers." It said there is a submission window running from March to May with final decisions expected in December. Importantly, the brokerage reported that its current estimates do not include credit for incremental capex; it described the upside from re-openers as an "asymmetric" risk to forecasts.
On allowed returns, RBC cited a 5.7% real return on equity for the water sector derived from a recent Competition and Markets Authority decision, aligning that outcome with RIIO-T3 levels. The brokerage also pointed out an approximate 60-basis-point gap between water returns and transmission returns.
For network businesses, RBC said companies are guiding to nominal returns above 9%, implying at least 130 basis points of outperformance relative to a 7.7% base return. The firm warned that earnings delivery across networks may be weighted toward the later years of regulatory periods because of project timing and incentive structures embedded in those frameworks.
Overall, RBC judged UK regulated utilities to be at the top of their European peer set on measures of asset and earnings growth, while noting the group generally lags peers on dividend yield. Pennon was cited as an exception to that yield gap, trading at about 120 basis points above the nearest peer on dividend yield metrics. Finally, the brokerage said balance sheets across the sector appear positioned to support planned capital expenditure over the next five years.
Key context provided by RBC:
- Inflation-linked regulatory frameworks and indexation of asset bases support cash flow growth for regulated utilities.
- Regulatory reviews and transition reporting - including PR29 - could alter returns and incentives, with broader structural reforms likely taking longer.
- Regulatory re-openers present potential capex upside, but current estimates do not include this additional spending.