Morgan Stanley sees limited gas regulation impact on utilities

Investing.com -- Morgan Stanley said the negative market reaction to Germany's draft gas regulation, which pushed down E.ON, Elia and RWE stocks, appears overblown and recommended buying all three stocks on weakness.

The draft gas network cost of equity stands at 4.9% post tax or 5.76% pre tax, which Morgan Stanley described as low. The firm noted this is a draft determination, not final, and emphasized that gas regulated asset base is not growing unlike electricity infrastructure.

Morgan Stanley said it sees limited direct read-across from headline returns for gas to electricity network stocks E.ON, Elia and RWE. The firm pointed to reassuring equity risk premium of 4.95% compared to its estimate of 4.88%, though the beta for gas at 0.62 is lower than the 0.81 expected for electricity.

The firm said it remains confident in electricity post tax cost of equity of around 6.5%. Using the gas beta would imply a worst case 5.6% cost of equity with 8%, 3% and 2% earnings per share downgrades for Elia, E.ON and RWE respectively.

Morgan Stanley called the initial negative market reaction misplaced, noting German electricity network stocks fell 4% for E.ON, 3.6% for Elia and 1.8% for RWE on Friday. The firm said the market is making direct read across from draft gas network regulatory allowed returns into electricity ahead of the draft determination expected in August 2027.

E.ON's German 2026 regulated asset base is 12% gas versus 88% electricity, while neither Elia nor RWE have any gas networks, according to Morgan Stanley.

The firm noted gas networks are not growing in Germany and therefore do not need to attract capital to fund capital expenditure growth, which differs materially from electricity networks. Morgan Stanley estimates E.ON German distribution system operator regulated asset base growth of 11% compound annual growth rate from 2026 to 2030, and Elia and RWE transmission system operator regulated asset base compound annual growth rate of 23% and 19% over the same period.

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