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By Abhinav Ramnarayan
LONDON, Nov 18 (Reuters) - British utilities are becoming
increasingly popular with bond investors who believe their debt
may benefit if a Labour government comes to power in December's
general election and takes them into public ownership.
Labour's finance spokesman John McDonnell last week detailed
the party's plans to nationalise parts of BT to provide
free broadband for all if it wins the election.
Previously, Britain's main opposition party has spoken about
plans to nationalise privately-owned, and in many cases publicly
listed, energy, water and rail companies should they come to
power.
Most opinion polls show the ruling Conservative Party with a
clear lead ahead of the Dec. 12 poll, suggesting a left-wing
government under Jeremy Corbyn is unlikely.
However, the Labour Party surpassed expectations at the
previous election in 2017 and a Corbyn victory would be viewed
as an unfavourable outcome by many in the financial markets
community.
But some corporate bond investors are more sanguine.
"We believe that it would be a quite favourable outcome for
British utilities on the debt side as the operating companies of
these utilities will become more closely aligned with the UK
government," said one portfolio manager who works for a British
fund manager.
As a result, he said the fund he works for has added British
utilities to their bond portfolios.
Utilities and telecoms collectively make up more than a
third of the 502 billion pounds ($651 billion) UK corporate bond
market, according to Refinitiv data. Of this, the energy and
power sector makes up about 22.8% while telecoms makes up
another 15.7%.
"Labour have stated they want to pursue a model similar to
TfL (Transport for London), which has a very close relationship
with the UK government and enjoys a very high credit rating as a
result," the investor added.
TfL, which runs London's underground and bus network, enjoys
a credit rating of AA- from ratings agencies S&P Global and
Fitch, just a notch below the UK government.
Recent bond issuance by British utilities ranging from
National Grid Electricity Transmission to Scottish
Power UK -- through its operating company SP
Transmission -- have all been met with strong demand. SP
Transmission's 350 million pound, 12-year bond issued early this
month, for example, received enough demand to cover the deal
nearly five times over.
A source close to that transaction said: "I think the market
gave us a really easy time, there were no questions over
nationalisation... I was actually astonished."
Investors say the rationale is clear.
"Labour publications suggest that bondholders at the
regulated ringfenced level could be 'honoured in full' and
refinanced over a period of time so that the costs of debt are
reduced," said Sharon Vieten, a credit analyst at fund manager
Columbia Threadneedle, in a July note.
She said the yield premium that investors demand to hold
utility bonds over benchmark UK government debt, known as gilts,
could fall.
"We estimate that at the 25-year maturity point, this
tightening could reach a scale of 20-45 basis points (of yield)
on UK gilts, compared to the current level of 140-160 basis
points," Vieten wrote.
There are also some signs of divergence within the structure
of company debt that show investors are playing a
nationalisation trade.
As Labour has said it will nationalise utilities at the
operating company level, investors have started favouring
operating company debt rather than holding company debt.
Energy firm SSE's February 2037 bond,
issued through its Southern Electricity Power Distribution plc
operating company, is now far outperforming an August 2038 bond
issued through the holding company, by almost 30
basis points on yield. Yields move inversely to prices.
One caveat is nationalisation would require additional
borrowing and could push gilt yields higher, hurting the credit
rating of the UK government and, by extension, British utility
debt.
Ratings agency Fitch warned last week that the election
pledges ahead of the vote heighten the United Kingdom's fiscal
risks.
But the portfolio manager said the nationalisation plans
wouldn't involve enough borrowing to put the 'Double A' UK
rating at risk, and wouldn't deter him from investing in British
utilities.
($1 = 0.7714 pounds)
(Reporting by Abhinav Ramnarayan; Editing by Toby Chopra)
