- National Grid is one of the largest utility companies delivering electricity and gas to customers and communities mainly in UK and US.
- The company has over 20 years of dividend growth. Dividend is expected to grow in line with CPIH in the future.
- Earnings of the company have been in a steady decline in the past and the trend continued in 2021 as adjusted EPS was 16% lower.
- The company is highly leveraged with Debt-to-Equity ratio of 157% and a debt is growing mainly due to the acquisition of Western Power Distribution.
- The stock price is fair by our stock evaluation method based on P/E.
Dividend Revenue Profitability Financial Strength Investment Case
British utility company National Grid (NG) owns electricity and natural gas transmission networks in the UK and the US. In the US it also produces and supplies both electricity and gas. The company’s vision is to be at the heart of a clean, fair and affordable energy future. The company has 2806 km of underground electricity cable and 7627 km of high-pressure gas pipe. Nearly 70% of group assets are focused on electricity. The company has the following divisions (each is run as end-to-end enterprise):
- UK Electricity Transmission – division owns the high-voltage electricity transmission network and distributes electricity in England and Wales. It has 7236 km of overhead electricity lines.
- UK Electricity System Operator (ESO) – ensures that supply and demand of electricity is balanced across Great Britain.
- UK Gas Transmission – owns and operates the high-pressure gas transmission network in Great Britain. It is responsible for gas transmission as well as for ensuring that supply and demand are balanced in real time.
- New England – owns transmission facilities and distribution networks in Massachusetts, New Hampshire and other US cities.
- New York – owns electricity transmission facilities and distribution networks across upstate New York as well as electricity generation facilities on Long Island. It also owns gas distribution networks across upstate New York, New York city and on Long Island.
- National Grid Ventures and other activities – manages diverse portfolio of complimentary energy businesses like commercial operations in energy metering, electricity interconnectors and other activity.
US Regulated division consists of New England and New York.
At the end of 2020 the company’s portfolio split was as follows.
National Grid acquired Western Power Distribution (WPD), the UK’s largest electricity distribution network, from PPL Corporation (to become part of the UK business unit). It is in the process of selling Rhode Island business in the US to PPL Corporation as well as selling majority stake in UK Gas Transmission and metering businesses. As a result the company has increased exposure to the UK’s electricity sector. WPD is looking to deliver over 200K charging points for electric vehicles across its territory by 2023.
|Dividend||Dividend Yield||5Y Growth||PayOut Ratio|
|GBP 0.492 per share||4.5%||2.65% per year||104%|
The dividend has been growing in the consistent and smooth way over the last 20 years.
In 2020 the dividend is 1.2% higher over year, in line with the increase in average UK retail price index as supposed by the previous dividend policy. In the future the company will aims to grow dividend in line with the rate of CPIH (the Consumer Prices Index including owner occupiers’ housing costs) inflation.
EPS of GBP 0.47 is lower than the dividend for 2020. So the dividend is not covered by earnings.
According to the company policy, dividend should grow at the rate of CPIH inflation. Bank of England expects inflation to rise to over 7% in spring 2022 and then fall back. We assume that the average dividend growth will be around 3% – 4% in the coming years.
|Revenue||5 Years Growth||Revenue growth in 2020|
|-0.45% p. a.
|Total sales +16.4%
By main divisions:
UK Electricity Transmission +8%
UK Gas Transmission -2%
US Regulated 0%
National Grid’s revenue is determined by tariff structure set by governments. As of November 2021 there are higher gas distribution rates for Massachusetts gas customers. Upstate New York agreement was renewed in July 2021. The company invested in critical infrastructure about GBP 5B in 2020. In the future National Grid will continue to develop infrastructure projects. For example, it is a co-participant to build the Northern New York Priority Project to unlock existing renewable energy resources such as wind and hydro power.
Utilities are facing pressure to decarbonize energy resources. National Grid committed to reduce direct emissions to net zero by 2050. Digital transformation should be part of the process to achieve greater efficiencies. For example, the company invested in Interconnector Monitoring and Response Center across North Sea Link and Viking Link interconnectors. Also it launched in the UK a one-stop portal for electricity connection customers. USD 6M was invested in two artificial intelligence start ups to secure critical network infrastructure.
In order to increase the future revenue the company aims to grow assets by 6%-8% each year. In 2020 asset growth was 5.6% and 9% in 2019.
National Grid provided the new 5-year outlook.
|Profit||5 Years Growth||Net Profit Margin||ROE||Company Outlook 2021|
|EPS GBP 0.47
Net Profit GBP 1.6B
|-7.4% p. a.
|ROE to grow 11% – 12.5% each year.
Earnings of the company have been in a steady decline over the past 5 years. In 2020 EPS was 27% higher and adjusted EPS was 16% lower. Operating profit was 4% higher over year while underlying operating profit was lower by 5%. Higher revenue in the US and in the UK’s Gas Transmission and NGV were more than offset by higher costs, including covid-related increase in bad debt costs in the US. Over year the company made a provision for bad debt of about GBP 0.18B in the US.
Divisions’ profitability has been as follows in 2020.
ROE is down for year from 12% to 10.6% in 2020. Highest ROE was in UK Electricity Transmission division, almost 14%.
The company has solid results in the first half of 2021 supported by the contribution from WPD.
It expects over GBP 0.4B per year in efficiency gains over the next three years.
As per the company’s outlook, we assume EPS growth of 6% per year on average in our projection of possible future investment returns.
Company Capital Structure
In EUR B
|Cash & cash equivalents||0.073||0.157|
|Net Debt (as defined by the company)||28.6||28.5|
The company is highly leveraged with Debt-to-Equity ratio of 157% and growing debt. The net debt (as defined by the company) has increased by GBP 12.9B to GBP 41.5B at the end of the first half year of 2021, 44% increase over year. It was mainly due to WPD cash paid and WPD net debt acquired.
Operating cash flow is only 15% of the debt and operating profit exceeds interest payments only by 3x. National Grid expects gearing (net debt-to-total regulatory assets ratio) to peak in 2022 settling above 70% which is very high. In March 2021 it was 65%. The Group has S&P credit rating of BBB+.
The estimate of future stock price and investment returns based on P/E ratio
|Assumptions of dividend and EPS growth over the next 5 years|
|Dividend could grow at 3% per year. So the total dividend income over the next 5 years would amount to GBP 2.69.
We could assume EPS growth of 6% p.a. Then EPS in 5 years will be GBP 0.63 per share.
|Projected stock price|
|Average P/E over the last 5 years (15.08) multiplied by EPS in 5 years = 15.08 x GBP 0.63 = GBP 9.48|
|Future Returns Based on the Assumptions|
*- Includes the expected dividend income over the next 5 years and dividends are not reinvested.
Geographic and regulatory diversity gives National Grid stability of performance. Asset growth should support expected earnings growth. Also the company should generate significant efficiencies through its efficiency program. However the stock is traded above its value under our assumptions. This defensive stock could be in investor’s watchlist and added to portfolio on any pullback.
I have no position in the stocks mentioned in this article and do not intend to initiate any position within the next 72 hours.
Data source – the company’s financial reports and presentations. Source of pictures – the company website unless otherwise stated. Colored circles next to headings mean an author’s evaluation of the relevant performance criteria of the company: green means positive, yellow neutral and red negative evaluation. There are many ways to estimate the future stock price. We use only one of them, the one based on P/E ratio. All estimates made in the article are for the informational purposes only. No taxation, brokerage fees and other expenses related to investing are considered in the estimates. The estimates are the result of the rule of thumb assumptions and the real outcome might differ materially from those estimates. As the future unfolds, macro events, not mentioned in the article, could impact the company fundamentals. Use the information in the article only as a starting point for your own due diligence.