GRAPHIC-European utilities' rising dividend yield is bad omen

* Utilities' rising dividend yield signals cuts likely

* High yield reflects share price falls

* Analysts expect sector payouts to be reduced - StarMine

* E.On's dividend seen at risk after RWE (LSE: 0HA0.L - news) cut

By Francesco Canepa

LONDON, Sept 25 (Reuters) - Rising dividend yields on European utility stocks may herald cuts in future payouts as investors sell out of a sector struggling with low demand, pressure from cash-hungry governments and regulation.

Despite a raft of dividend cuts in recent years, the yield on the MSCI (NYSE: MSCI - news) pan-European utilities index - which compares the size of the most recent payout with the share price - has risen to 6.8 percent, the highest of any sector and nearly twice the market average, monthly data from Thomson Reuters Datastream showed.

The rise in yield reflects a 32 percent share price fall between May 2011 and September 2013. Since investors mainly buy low-growth, highly regulated utility shares for their dividend, the yield spike should make investors wary, rather than optimistic, about future payments.

"When you look at the headline dividend yield, either the sector is extremely cheap or dividends are going to be cut," Ashley Thomas, an analyst at Societe Generale (Paris: FR0000130809 - news) , said. "And we would say that dividends will continue to be cut."

Analysts cut their 2013 dividend estimates for European utilities by 1.7 percent over the last 30 days, the steepest cut for any European sector and 50 percent more than second-ranked basic materials stocks, Thomson Reuters StarMine data showed.

The yield is expected to fall to 5.1 percent next year from 12.9 percent in 2013, according to StarMine's SmartEstimates, which use forecasts from analysts with the best track record. This would bring the sector closer to a market average of 3.7 percent and below the yield on energy stocks.

German multi-utility groups E.On and RWE (Xetra: 703712 - news) , hit by Germany's switch out of nuclear energy and falling power prices, have borne the brunt of recent cuts.

Estimates for E.On's next dividend have fallen 2 percent in the past 30 days and some investors believed it may echo smaller rival RWE, which halved its dividend last week.

Both RWE and E.On offer an 8 percent yield based on this year's dividend, the highest among multi-utilities, but this is expected to fall to 4.4 percent and 4.5 percent, respectively, next year, SmartEstimates showed.

"If RWE is doing it, it wouldn't necessarily be a surprise if E.On did the same," said Will James, manager of Standard Life's European Equity Income fund. "(As an investor) you just have to make sure you're not too yield-hungry."

Utilities are also under pressure elsewhere.

A UK tax on carbon, part of the government's efforts to cut emissions, hit first-half profits at coal-fired power producer Drax, resulting in analysts cutting dividend estimates by 0.4 percent in the past month.

Drax's dividend yield is expected to fall to 2.4 percent in 2014 from 2.9 percent this year.

Shares in Britain's two biggest utilities, Centrica and SSE (LSE: SSE.L - news) , tumbled on Wednesday after the opposition Labour party said it would freeze energy prices if elected in 2015.

An overhaul of Spain's energy sector, aimed at plugging a gap between regulated power prices and generation costs, has affected grid operator Red Electrica (Madrid: REE.MC - news) de Espana (REE) and utility Endesa.

Endesa skipped a payout this year and analysts have cut their estimates for the next one by 19 percent in the past month. Estimates for REE have been cut by 0.8 percent.