By Sudip Kar-Gupta and Alistair Smout
LONDON (Reuters) - While UK stocks have broadly shrugged off the looming general election, some investors are shunning a sector that risks becoming a political punch bag.
Domestic utilities including Centrica (L:CNA) and SSE (L:SSE) have fallen since the start of 2015, even as the FTSE 100 index (FTSE) has hit record highs. An array of negatives, from weaker oil prices and dividend cuts to fears of an interest-rate hike, have dragged down the FTSE 350 utilities index (FTUB7500).
Politics is another risk factor to add to that list, investors and analysts say.
High energy prices have long been a political football. The opposition Labour Party is campaigning to give the energy regulator the power to force firms to cut prices in response to falls in wholesale costs, while Energy Secretary Ed Davey has warned that former gas monopoly British Gas might have to be broken up.
The UK competition authority is investigating the energy market over concerns of opaque pricing and uncompetitive retail offerings, with the results due at the end of this year.
With two months to go before the election, most polls show the opposition Labour Party running neck-and-neck with the right-wing Conservatives who dominate the ruling coalition, and who may themselves strike a more populist tone in response.
Last time Labour returned to power after a period out of office in 1997, it imposed a windfall tax on utilities. Its promise in 2013 to freeze prices put the sector back in the spotlight, and some investors are choosing to steer clear of utilities once again.
"The utility sector in the UK, despite privatisation, remains subject to political drivers and in the run-up to the UK elections on May 7, we continue to see political risks as one of the key reasons to be cautious," said RBC Capital Markets' analyst John Musk.
The shares of British Gas owner Centrica (L:CNA) have fallen nearly 20 percent over the last month, while SSE (L:SSE), United Utilities (L:UU) and National Grid (L:NG) are down around 5 percent.
Musk's team at RBC saw Centrica and SSE as among the most exposed of the utility stocks, given their large customer-facing retail operations.
"We see few reasons for either Centrica or SSE to reverse this underperformance in the run-up to the general election, and a Labour victory, or Labour-led coalition victory, may result in further underperformance post-election," added Musk.
DIVIDEND CUTS
The utility sector, traditionally favoured by investors for its chunky dividend yields, has already witnessed dividend cuts by both Centrica and water company Severn Trent so far this year, reducing the sector's appeal further.
According to Thomson Reuters StarMine, the sector is trading at a slight discount to the broader FTSE 100 in terms of future valuation. StarMine data show it on a price-to-future earnings (P/E) ratio of 15.3 for the next 12 months, compared to 16.1 for the FTSE 100.
Severn Trent said its dividend cut had been a response to tighter profit rules imposed by industry regulator Ofwat.
Ofwat's counterpart Ofgem, which regulates electricity and power companies, noted as far back as 2006 the possibility that its rules on pricing had been overly generous to network owners. (http://uk.reuters.com/article/2013/12/02/uk-britain-energy-insight-idUKBRE9B100920131202)
The mounting pressure has prompted a response from the government, led by the centre-right Conservatives. It ordered a review of competition in the energy retail sector in October 2013 after Labour's price-freeze proposals proved popular. Concerns over competition in the sector have been referred to the Competition and Markets Authority.
The likelihood that no party wins an outright majority in the election creates an added uncertainty, with the Scottish National Party (SNP) looking set to become power brokers.
Before last year's independence referendum, investment managers BlackRock said regulation of utilities was likely to increase in an independent Scotland. In the event, Scots voted not to break away, but a strong SNP showing in this election could bring another vote, or at least further devolution, on to the agenda.
The tenor of the debate heading into the election leaves few feeling optimistic for the sector's future.
"I am trying to avoid utilities and am very underweight in that area. We have been trying to avoid some of those areas that look like they could become political footballs," said Chris White, fund manager at Premier Asset Management.