Investing.com -- Jefferies analysts have revised their ratings on two major UK utility stocks, downgrading both United Utilities (OTC:UUGRY) and Severn Trent (LON:SVT) to "hold" from "buy."
The adjustments come ahead of an important regulatory update for the water sector expected later this month.
While the analysts maintain cautious optimism regarding Ofwat's final determinations on December 19, they cited a more balanced risk-reward outlook for these stocks given current valuations and regulatory uncertainties.
Jefferies cut United Utilities’ price target by 3% to 1,190p, reflecting a tempered outlook on its equity returns and regulatory challenges.
United Utilities is currently trading at a 10% premium to its regulatory capital value, slightly below its five-year average of 13%.
Analysts expect Ofwat's determinations to provide clarity on the company’s ability to deliver its targeted 6.2% real equity returns, including 5.2% base returns and 100 basis points of outperformance.
However, they noted concerns over the company's balance sheet. Moody’s has placed United Utilities on a negative outlook, raising the prospect of an equity raise or dividend adjustment in the future. The analysts see limited upside at current valuations and thus consider the stock to be fairly priced.
Similarly, Jefferies reduced Severn Trent’s price target by 1% to 2,830p. Severn Trent (NS:TREN) currently trades at a 20% premium to its RCV, supported by its strong track record of outperformance on output delivery incentives.
However, analysts expect a tougher regulatory environment to limit the company's ability to replicate past outperformance.
Additionally, while Severn Trent's proactive £1 billion equity raise last year has strengthened its balance sheet and provided stability, Jefferies sees its valuation as already reflecting these advantages. As a result, they project limited gains from the current levels.
Shares of both United Utilities and Severn Trent were down over 1% each at 9:12 ET (14:12 GMT).