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Goldman Sachs is the latest broker to warn of future dividend cuts following Ofwat's publication of the draft tariff proposal for the next five years.
The water industry regulator says the lower rate of returns will have a great impact on earnings and lead to dividend cuts of up to 20% in its forecasts for United Utilities, 5p cheaper at 447.9p, and Severn Trent, up 7½p at 971p, by 2011.
Goldman has also slashed its 12-month price target for UU from 549p to 420p and for Severn Trent from 1451p to 1179p. It has added UU to its influential conviction sell list. “Picking winners and losers within the UK water sub-sector has become increasingly valuable over the past four price reviews. UU has been a persistent underperformer.”
The broker points out that the last time the regulator cut the allowed rate of return was in 1999, when the draft proposal was to reduce the rate from 5.6% to somewhere between 4.25% and 5.25%. The final result was a rate of 4.75%.
On average, the water companies went on to underperform the utilities sector by more than 20% between the draft and final determinations in 1999, ending the year with more than 30% relative underperformance. Pennon firmed 0.4p to 459.8p.
Leading shares generally fell sharply as their recent strong run gave way to profit taking. The FTSE 100 index fell 44.09 to 4638.37. The lead index has come up 32% from its low-point in March, buoyed by hopes that the recession has bottomed out.
Dealers say hedge funds are feeling the pain having already gone short of the market before the second-quarter reporting season got under way. Their situation has been made worse by the long-only and income funds piling in to make up the lost ground. Even second-liners struggled to keep their heads above water with the FTSE 250 index shading 3.5 at 8154.6.
Not everyone was sucked in by Barclays' second-quarter results yesterday, which produced an 8% rise in pre-tax profits. Sandy Chen at Panmure Gordon remains a seller of Barclays, up 2.1p at 324.7p, while JPMorgan reckons the current pace of growth is unsustainable. It remains underweight in the shares and says there is scope for a 27% fall in the share price to around the 220p level. Nomura has a buy rating on Barclays but has trimmed its target from 320p to 309p, while S&P Equity Research has raised its sights from 300p to 340p.
Anglo-Swiss mining giant Xstrata responded to a drop in half-year profits with a rise of 31p to 834p. The company gave no indication that it was prepared to offer Anglo American shareholders anything extra for them to back the proposed £41 billion merger, which has already been flatly rejected by the AA board. Sensing that the deal may be close to collapse, shares of AA fell 74½p to 1948½p with Investec repeating its hold rating on the shares and lifting its target from 1800p to 2000p.
But Xstrata's chief executive Mick Davis stirred the pot by saying that he saw platinum producer Lonmin as a “tremendously good option”. Last year's bid by Xstrata for Lonmin ended in failure but the speculators are hoping Xstrata might try again. But Lonmin appeared unimpressed falling 40p to 1386p.
Mining shares generally came in for profit taking with Rio Tinto falling 84p to 2526p while Randgold Resources shed 65p at 3780p and Antofagasta dropped 42p to 755p.
Shares in Home Retail suffered a double whammy which left the share price nursing a loss of 8p at 303¾p. Cazenove has decided to downgrade the Burberry and Homebase DIY stores group to a sell and rival Nomura has dropped its rating from buy to neutral.
Dana Petroleum, a firm favourite with the speculators, suffered a reaction falling 20p to 1402p. The oil and gas explorer says drilling at its TAJ-1 well in Morocco has found insufficient gas to make it commercially viable. The well has now been plugged. Back in May, Dana raised £56 million by way of a placing of new shares at 1290p. In June, the company was forced to deny gossip that it had received a bid approach worth 1800p a share.
Gulf Keystone Petroleum, which tapped shareholders for £6.8 million worth extra funds by way of a placing yesterday, retreated ½p to 12½p. RBC clearly does not expect fireworks from the oil explorer. It has slashed its target price from 23p to 10p with a sector perform rating. Last week, Gulf Keystone denied claims it was the target of a bid by Indian Oil Corporation.
