The Capital Cycle Podcast - A Different Network Effect

Episode Date: November 26, 2025

The long-term appeal of European utility networks. Edward Chancellor talks to Ben Slingsby, a European Analyst. For more information, or to access select articles from Marathon’s Global Investment Review publications which accompany this podcast series, please visit www.thecapitalcycle.co.uk Hosted on Acast. See acast.com/privacy for more information.

Hello, this is Edward Chancellor with another episode of the capital cycle podcast, and I've got with me Ben Slingsby, who is an analyst on Marathons European portfolios. Welcome, Ben. Thanks for having me, Edward. Now, Ben, in your recent global investment review, you talk about network effects, and you start by making this point that network effects have been a critical source of competitive advantage in the tech sector, as we all know, you question that this advantage that they have had, the big tech network effects might not be sustained going forward. And so you find a different

network to get excited about. And that's namely the relatively mundane utility power networks or grids. Tell me, Ben, why you find the European grids attractive? I like them because they are monopoly businesses whose core growth rate has accelerated to low double digits and continues to rise. The lack of power has become a key bottleneck slowing the AI data centre build out. And AI data centre stuffed with their GPUs required massive amounts of power. Exactly. It turns out that energy is as vital to AI as water is to fish. US investors across the pond seem to recognise this trend earlier than their European counterparts, but perhaps that's because the data centre build out is more advanced stateside.

It feels like we're still in a fairly early innings of this as a European catch-up trade, and this should benefit European utility stocks. Now, European utility stocks are not widely owned, you say, in global portfolios of active managers, and not in the popular so-called quality growth funds. So why do quality investors shun utilities? Well, the pushback I usually get. from PM's portfolio managers is that they are one, two capital intensive, two levered and three carry too much regulatory risk. There's also a lot of sector-specific regulation and jargon of

regulated asset bases and allowed returns, which many generalist investors deem too complex. Let's start with capital intensity. You compare the grid's capital spending plans to the big tech hypers. Yes. On that first bare point I mentioned, high capital intensity. This is actually converging between hypers' scalers and power networks, interestingly. So Mehta's capex, the revenue ratio, for example, is now above that of the average utility, and it's even above AT&Ts during the last tech bubble in 2000. Meta's return on investment is very uncertain, whereas growth capex into a power network earns a guaranteed, regulated return, typically around the 9 to 10% return on equity level.

And that's important from a capital cycle perspective, because grids don't suffer as much from pickup in capital spending compared to other sectors? Yes, that's right. Regulation allows utilities to defy the capital cycle, if you will. Returns do not decrease as more capital goes into the networks because regulation guarantees that return on equity. So network businesses are natural monopolies with no competition. That return is very no risk. And you believe the sector can earn decent returns from its ongoing capital spending? Yes, right now it feels like regulators are.

are incentivised to grant fare returns, which means that the power networks have an increasing number of attractive capital allocation opportunities. Power networks can also sell existing assets at decent multiples if they need to deliver to fund growth. Private equity and private infrastructure funds have about $2.5 trillion of dry power globally, and they are seeking cash generative assets like power grids. They have been buying stakes and grids at higher valuations that is implied by listed utility share prices and their fund structures enable higher leverage. Additionally, rates have been coming down from recent peaks, lowering the cost of funding and boosting grid valuations. And you believe that the power grid's almost certain to maintain their dominant positions, whereas that can't necessarily be said for the tech giants?

Yes, I think the leading power grid monopoly in a region today will almost certainly be the key player in, say, two decades time. In contrast, how often has a leading tech player been able to avoid disruption over a multi-decade period? especially in a time of such unprecedented technological change as now. I guess putting it another way, a pound of capex invested into a UK power transmission network and regulated inflation-linked cash flow for 45 years. And this contrasts quite sharply with the asset lives of tech infrastructure and semiconductors where depreciation rates of over five years appear pretty optimistic given the pace of innovation. And on your second bare point, high leverage, you say that quality growth,

investors shun sectors that use debt to boost returns on equity. Now, this might, in some cases, be justified. We've read a lot over the last couple of years about the travails of Thames Water, the formerly highly leveraged poor performing water utility that has been in state of more or less collapse. I'm assuming that your European grid operators aren't leaking in the same way as Thames Water. Yes, public market investors would not tolerate the levels of leverage that we've seen at some of the privately owned utilities like Thames. The listed power players have been much more disciplined. The electricity utility's debt is typically termed out sort of 10 years in the case of national grid and debt levels are much more manageable. As you know, leverage only becomes a problem

when it can't be repaid. These power networks have highly predictable regulated cash flows and their own appropriate hard assets to borrow against. Additionally, key players like Ibidrola and National Grid have recently raised equity to fund their vast growth CAPEX programs. So their balance sheets are very strong right now. These were not distressed capital raises by troubled businesses, but rather positive capital raises that the market has taken very well. And these companies enjoy favourable financing costs at the moment?

Yes, CAPEX could be financed pretty cheaply, enabling a positive spread versus the true cost of capital, thus creating a shareholder value. For example, this summer, the leading German utility Eon, issued green bonds due in 2013 at just a 3% coupon. Utilities are seeing high levels of capital intensity because they have such large and attractive growth opportunities at solid returns. Their addressful market today is vast and increasing with McKinsey estimating that global grid spend will ramp to $1.2 trillion per annum by 2040. And the third bearish point that leads investors to shun the utilities, regulatory risk? Yes, there's no denying that the networks are highly regulated, as they are true monopolies.

It would be absurdly expensive to try and build out a duplicate grid alongside existing cables. But in exchange for no competition, regulators cap the returns they are allowed to make to keep end customer bills down. The good news is that regulators across developed markets are generally increasing returns. They recognise the need for utilities to spend huge amounts. of capital over the coming years, and stretch government balance sheets cannot fund that investment. Private capital is needed. Competition for that capital is global, and so insufficient returns on offer would see funding head elsewhere. Incentives are therefore aligned currently between the networks and their regulators. So these European utility stocks have been doing relatively well recently.

Yes, after two years of underperformance, over the past year, European utilities have beaten the index MSCI Europe by 18 percent, and the S&P 500. by 31% in dollar terms, and investors that have owned the leading Spanish utility Ibrugrola for the past decade have beaten those indices by 228 percentage points and 61 percentage points, respectively. And yet, despite this good performance valuations still appear relatively attractive. Yes, despite recent strength, utility valuations remain close to in line with long-term averages and as a discount versus the European market. We think the improved fundamentals ahead, argue for a sustainably rating and higher multiples.

The stocks have done well because their growth rates have doubled in recent years, but that was actually before AI became a key theme. The first wave of this has been driven by the electrification megatrend. The penetration rates of renewable power generation and electric vehicles have been rising in Europe before AI arrived. In your piece, you have a chart that shows US electricity production taking off over the last few years and European production declining.

And you suggest that this is grounds for expecting a European catch-up. I think the counterpoint to that argument would be to say that the reason European electricity consumption and production has been relatively weak compared to the US is simply because European electricity costs are so high. You don't think that's going to be a problem going forward? Yes, that's correct. Europe does not have the same abundant, cheap energy resources

as the US, but renewable energy is viewed as one answer. Often renewable power generation is located a long way from the demand centres in Europe, so it's windiest offshore in northern Scotland, over 500 miles from London. That means that huge cables are being built to move the power south to where it's needed, and the power network stocks are benefiting. You're saying there's going to be an additional boost to demand from power-hungry data centres in Europe. Yes, so it feels like that theme has now arrived in Europe, with Goldman Sachs estimating that the current data centre pipeline has increased 65% in the past nine months to a total of 280 gigawatts.

That's equivalent to about 90% of all existing power demand in the EU today. And supply is tight? Yes, the UK energy system, for example, is literally gridlocked. So the UK grid connection queue has grown 10fold over the past five years and the current wait time is 15 years if you want to try and connect a new solar or wind farm. So extending and upgrading power grids is a key part of the solution. National Grids UK electricity transmission business is now growing at 11% per annum, for example, up from just 4%, 6 years ago, because of that mega trend that we've discussed. So by way of conclusion, you think that these, what some investors might call slightly dial stocks, are almost ideal investments. Talk us through that.

Well, if we think about sort of the ideal stock potentially in today's environment, it would need to offer alpha. In other words, beat the market. Yes, exactly. A market beating total shareholder return of, say, low double digits versus long-term returns for the MSCI Europe index of 6 to 8%. European Power Network stocks typically offer mid to high single digit earnings per share growth, plus a circa 4% dividend yield, summing up to a low double digit total shareholder return, Ketaris Paribus. Secondly, the stock will be protected from the capital cycle and monopoly business with no threat of competition disrupting it. Ideally, the stock might sit in a sector that is not widely owned globally by active investors. Growth in the core business would be accelerating structurally. And the stock would capture some of the upside from the current key market theme of AI, but also be defensive and outperform if AI investment diminishes. Finally, valuation would be reasonable. So it might not be listed in the richly valued US market,

but probably listed in Europe today. So your stock picks that you have in the European portfolios, I take it at National Grid and Ibadrola. Yes, National Grid and Ibrahimadrola are owned in Marathons, UK and European portfolios. Ibrador is quite literally a global powerhouse with assets in Spain, the US, the UK and Brazil, mainly electricity networks. Ibrador's chairman owns about 16 million shares worth $325 million, so incentives are nicely aligned. Overall, the stock feels likely to continue to power on for the long-term investor. Great. Thanks a lot, Ben.

Thank you very much for having me, Edward. Thank you for your time today. I hope you will listen to the next edition of the Capital Cycle. This communication is provided for information purposes only. Please refer to Marathon's website and the Global Investment Reviews for further information, including important disclosures.