TSX lower after index logs fresh record closing high
Investing.com -- Rising bond yields and weaker energy prices have prompted Barclays strategists to advise investors to steer clear of European utilities, warning that share prices have outpaced fundamentals.
In their September update, the bank’s strategists downgraded the sector to underweight, pointing to “strong performance YTD and risks from higher rates and lower energy prices” as the drivers.
They argued that valuations now look stretched, with utilities vulnerable to a correction as borrowing costs rise and commodity support wanes.
“Share prices have moved ahead of fundamentals now, making it look a bit extended,” the strategists said, flagging that the SX6P index has fallen against a backdrop of rising interest rates.
The sensitivity of utilities to yields varies across subsectors. Barclays estimated that every 10 basis point change in the weighted average cost of capital impacts regulated companies by about 1%, vertically integrated names by 1.7%, and renewables by as much as 2.4%.
That leaves renewable-focused firms particularly exposed to rate hikes. “Renewables are most exposed to bond yield moves whilst regulated are least,” the brokerage noted.
Despite the downgrade, Barclays’ equity research analysts maintained a positive stance on European utilities.
They argued that valuations remain relatively attractive, with the sector trading at 13 times one-year forward earnings, about 11% below the 10-year average of 14.6 times.
“Undemanding valuation with 1-year forward PE nearly 1 std lower than long run average,” they said, adding that they expect earnings to recover in 2026 and 2027 after a trough this year.
Dividend support also remains strong, with utilities offering a roughly 5% yield and medium-term total shareholder return potential of about 12%.
Barclays flagged “ robust future earnings growth prospects (~7%) and superior dividend yield (~5%), potentially translating into a ~12% TSR over the medium to long term.”
Still, the macro backdrop poses challenges. Political and fiscal strains in the UK and France, coupled with elevated bond yields, have weighed on sentiment.
In the UK, Chancellor Rachel Reeves faces pressure ahead of the Nov. 26 budget to rein in public finances while higher gilt yields add more than £3 billion to debt interest costs.
In France, Prime Minister Francois Bayrou’s call for a confidence vote on his budget plan underscored fiscal uncertainty after the deficit swelled to 5.8% of GDP.
Commodity prices, another key driver, have shown signs of weakness. Barclays pointed to a decline in European gas storage levels, about 20% lower this summer compared with last year, and noted that market reactions to geopolitical events, such as the Trump-Putin summit in August, triggered declines in forward gas prices.
“We do not see oversupply in European Gas flows until FY27,” the analysts said, but they acknowledged that short-term price pressures remain.
The divergence within Barclays’ own analysis underscores the tension between long-term structural growth opportunities in clean energy and the near-term drag from higher rates and weaker commodities. For now, the brokerage’s strategists caution that the risks outweigh the rewards.