Valuing European regulated utilities: RAB premium is the core anchor, and interest rates are not the only variable

Overview

This report is the second part of Bernstein's European Utilities and Clean Energy Regulated Networks primer series, focusing on valuation methodologies for regulated network companies. The report argues that the revenue and capital recovery mechanisms of regulated utilities usually revolve around the Regulated Asset Base (RAB), making RAB and its premium key to understanding valuation. Companies that can generate returns above their cost of capital under a supportive regulatory framework and have visible capex and RAB growth should generally deserve higher valuation premiums; conversely, low growth, low returns, or company-specific risks will दबress premiums.

Core views

The core views include: first, RAB is the foundation of regulated network valuation, and historically the market value of most regulated companies has been highly correlated with changes in RAB; second, the main drivers of the RAB premium are the spread of actual returns relative to cost of capital, regulatory attractiveness, sustainable RAB growth, and operational or financial outperformance; third, regulatory reset cycles can cause valuation volatility, especially before final regulatory determinations; fourth, regulated utilities are not simple bond proxies, as many regulatory regimes can cushion interest rate changes through dynamic adjustments to allowed cost of capital; fifth, P/E and dividend yield may be distorted by accounting treatment, regulatory depreciation, inflation treatment, capex needs, and non-regulated earnings, and should not be used as the sole valuation anchors.

Analysis framework

The report analyzes the topic through a combination of theoretical valuation frameworks, cross-jurisdiction comparisons, historical regressions, case studies, and trading multiples. It focuses on comparing allowed ROE across different European regulatory regimes, spreads versus 10-year sovereign bond yields, regulatory attractiveness, RAB growth expectations, RAB premiums, dividend yields, P/E, and the historical relationship between interest rate changes and valuations.

Methodology notes

• Valuation FrameworkRAB Premium Valuation Framework

  Premium or discount of enterprise value relative to the Regulated Asset Base

  This framework compares enterprise value excluding non-regulated assets with RAB to measure how the market prices the future cash flows, growth, and excess returns of regulated assets.

• Fundamental Driver AnalysisSpread Between Actual Returns and Cost of Capital

  The extent to which actual or allowed returns exceed the cost of capital

  If the returns allowed by the regulatory regime and the returns actually achieved by the company exceed the cost of capital, and there is room for outperformance, the market is usually willing to assign a higher RAB premium.

• Growth ValuationRAB Growth Combined with DCF

  Use DCF during the explicit forecast period and a long-term RAB premium assumption for terminal value

  The report states that most regulated utilities can be valued using DCF during the explicit forecast period, while in the terminal stage a RAB premium is assigned based on long-term growth and the spread over cost of capital assumptions.

• Empirical TestingRAB-Market Cap Regression and Interest Rate Correlation Testing

  Test valuation anchors using historical RAB, market capitalization, and bond yield data

  The report uses data since 2005 or 2010 to observe the correlation between RAB and adjusted market capitalization, and uses long-term multi-region data to test the relationship between utility valuations and government bond yields.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• European regulated utilities

  Core covered asset class

  Strengths

  Higher revenue predictability, capex plans are usually relatively clear over multi-year regulatory cycles, and RAB provides a valuation anchor.

  Weaknesses

  Valuation is affected by regulatory regimes, interest rates, cost of capital, and regulatory resets, and systems differ significantly across countries.

  Comparison

  Compared with ordinary high-dividend stocks, regulated networks rely more on RAB growth and allowed returns; compared with bonds, returns can change through dynamic regulatory mechanisms, capex growth, and outperformance.

  Risks

  Adverse regulatory rulings, failure to timely pass through rising cost of capital, financing pressure, political intervention, and company-specific events.

• Terna

  A positive case of correlation between RAB growth and market value

  Strengths

  From 2005 to 2025, RAB and market value grew in tandem, with strong historical correlation, and Italian regulatory returns are relatively attractive.

  Weaknesses

  Valuation still depends on the stability of the Italian regulatory regime and future capex execution.

  Comparison

  The report states that although Terna has lower RAB growth than Elia, it commands a higher RAB premium because of higher regulatory returns.

  Risks

  Cuts to regulatory returns, weaker-than-expected capex execution, and changes in interest rates or sovereign risk.

• Elia

  A case of high growth constrained by financing capacity

  Strengths

  Strong RAB growth outlook, especially driven by transmission investment needs.

  Weaknesses

  Large-scale growth requires external financing, and financing uncertainty has previously materially depressed valuation.

  Comparison

  Compared with Terna, Elia is growing faster, but regulatory returns and financing pressure mean its RAB premium is not necessarily higher.

  Risks

  Equity financing dilution, changes in financing commitments, and insufficient regulatory returns in Germany and Belgium.

• Redeia

  A case of low RAB premium and company-specific risk

  Strengths

  Has a base of regulated grid assets.

  Weaknesses

  Spain's regulatory regime is described in the report as one of the less attractive in Europe, and there is potential compensation risk related to the April 2025 blackout.

  Comparison

  The report states that Redeia has a relatively low RAB premium among electricity network companies, partly reflecting the weaker attractiveness of the Spanish regulatory framework.

  Risks

  Regulatory investigations, third-party compensation claims, and low regulatory returns.

• E.ON

  A case where the applicability of the RAB framework is affected by non-regulated earnings

  Strengths

  Its business includes a substantial amount of network assets.

  Weaknesses

  Network earnings include equity-accounted income and adjacent business income that are not included in RAB, reducing the purity of the RAB premium framework.

  Comparison

  Compared with pure regulated network companies, a simple RAB premium multiple cannot be directly applied to E.ON.

  Risks

  Volatility in non-regulated earnings, unclear asset scope, and valuation sum-of-parts errors.

• Enagas

  An exceptional case where the RAB framework may undervalue the business

  Strengths

  Despite declining RAB, certain gas transmission, regasification, and storage assets still have relatively attractive remuneration arrangements.

  Weaknesses

  Mature infrastructure leads to declining RAB, limiting the explanatory power of the traditional RAB growth framework.

  Comparison

  Unlike grid companies that rely on RAB expansion, Enagas derives more of its value from special asset life-extension incentives and remuneration mechanisms.

  Risks

  Changes to special incentives, declining utilization of gas infrastructure, and regulatory regime changes.

Key data

• Terna RAB GrowthFrom 2005 to 2025, RAB increased from about €5.2bn to €24.9bn, up by about €19.6bn, or roughly 378%During the same period, market capitalization increased by about €14.0bn, or roughly 337%, and cumulative dividends of about €9.5bn were paid.
• Correlation Between Terna RAB and Market ValueR-squared of about 0.9The report uses Terna as a case study to show the strong correlation between changes in RAB and changes in market value.
• Terna Shareholder ReturnAverage annual TSR of about 12.8% from 2005 to 2025Of this, market cap CAGR was about 7.7%, and dividend contribution was about 5%, close to the roughly 8% RAB CAGR plus an average annual dividend yield of about 5%.
• Recent Transaction RAB PremiumsElectricity North West about 45%, UK Power Networks about 50%, WPD above 60%The report uses M&A cases to show that high-quality regulated network assets can command relatively high RAB premiums.
• Ofwat Long-term Water RAV PremiumAverage of about 10% from 1993 to 2024The historical range has fluctuated significantly, reaching about 35% in the late 1990s and at times trading at a discount.
• Comparison Between Terna and EliaElia three-year forward RAB growth of about 22% p.a. versus Terna about 10% p.a.; however, Terna RAB premium is about 33% versus Elia about 29%The report believes the difference may stem from higher regulatory returns in Italy, while the German regime offers lower allowed ROE for both new and old assets.
• Theoretical RAB Premium ModelIf actual returns exceed the cost of capital by 10% and there is no RAB growth, the theoretical RAB premium is about 10%; with an additional 10-year 10% RAB CAGR, the premium is about 26%; with an additional 15% RAB CAGR, the premium is about 41%The model assumes RAB growth is 0% after 10 years.
• Elia Financing EventAnnounced about €2.2bn equity financing on March 7, 2025Prior financing concerns had reduced its premium to 2024 RAB from about 25% to around 0%; after the financing, the premium rebounded to above 20%.

Impact & implications

For investors, European regulated utilities should not be priced solely as interest-rate-sensitive high-dividend assets; priority should instead be given to assessing regulatory quality, the spread between allowed returns and cost of capital, visibility of RAB growth, ability to finance capex, and company-specific risks. High valuations do not necessarily mean expensive valuations; if high RAB growth and high returns are sustainable, the premium may have fundamental support. However, for companies facing regulatory resets, financing pressure, or substantial non-regulated earnings, the RAB framework needs to be adjusted with caution.

Risks

• Regulatory cycle resets may lead to lower allowed returns or investors compressing valuation multiples in advance.
• If actual returns cannot cover the cost of capital, RAB growth may fail to create shareholder value.
• High-growth companies with insufficient financing capacity may face equity financing pressure, dilution risk, and valuation discounts.
• Company-specific events may overwhelm the advantages of the regulatory framework, such as Redeia's blackout compensation risk.
• Non-regulated earnings, accounting treatment, inflation treatment, and regulatory depreciation can distort comparisons of P/E, dividend yield, and RAB premium.
• The relationship between interest rate changes and valuations is not stable, but if a regulatory regime lacks dynamic cost of capital adjustment, rising rates may still create pressure.

What to watch

• Allowed ROE, WACC, and inflation protection mechanisms in the next round of regulatory determinations across countries.
• Whether RAB growth comes from capex that is approvable, financeable, and able to earn reasonable returns.
• Whether companies have sufficient financing capacity, especially high-growth transmission and grid companies.
• Changes in regulatory regimes across major jurisdictions such as the UK, Belgium, Italy, Germany, and Spain.
• Whether the correlation between RAB premiums and regulatory attractiveness continues to hold.
• Whether declining dividend yields reflect high-quality growth investment or cash flow pressure.
• When P/E diverges from RAB premium, whether this is caused by IFRS earnings, regulatory earnings, inflation methodology, or non-regulated businesses.