National Grid 4% Yield Offers "Solid Returns"

National Grid has grown into one of the largest utilities in the world since since U.K. regulators unbundled energy distribution, transmission, and supply in the 1980s

Travis Miller 23 May, 2017 | 3:24PM
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National Grid's (NG.) core U.K. transmission and U.S. regulated gas and electric distribution utilities continue to perform well. New rate schemes in the United States and continued incentive revenue in the United Kingdom are resulting in earned returns on equity that are 100-200 basis points higher than U.S.-based regulated utilities. This supports a dividend pay-out above 70% and extra leverage with no distress concerns. But dividend growth at a 2% inflation rate is meagre relative to peers. We don't see that changing anytime soon because of Grid's growth investment plans and already-high pay-out ratio. Instead, we expect its 4% yield and rapid book value growth to offer solid returns. 

Dividend growth at a 2% inflation rate is meagre relative to peers

Morningstar analysts are reaffirming our £10.20 per share fair value estimates for National Grid after the company reported 2016-17 fiscal-year adjusted earnings of 73p per share, in line with our estimate. Pro forma earnings on a go-forward basis were closer to 59.2p per share.

National Grid's £3.2 billion special dividend 84.4p per share will not have a material impact on our £10.20 fair value estimate because of a concurrent 11-for-12 share consolidation. The lower share count will entirely offset our lower ex-dividend total equity value.

National Grid also plans at least £800 million of stock buybacks this year and has the option to divest itself of an additional 14% of its current 39% stake in the U.K. distribution business. Therefore, we expect our estimates for earnings per share and other financial measures will change throughout the year, but we don't anticipate a significant change in our fair value estimate. With the stock trading near our fair value estimate as of late May, we expect any buybacks will be value-neutral.

Investment Thesis

National Grid has grown into one of the largest utilities in the world since since U.K. regulators unbundled energy distribution, transmission, and supply in the 1980s. National Grid began acquiring Northeastern U.S. utilities in 2000 and made its biggest move buying New York-based Keyspan for $11.8 billion in August 2007.

National Grid earns about 30% of its profits from the United States, but that is rising as the U.S. dollar strengthens, U.S. regulation improves, and National Grid pursues large investment opportunities in the U.S. The agreed sale of its U.K. gas distribution business also will boost the share of U.S. earnings slightly. Even though U.K. regulation is more constructive right now, the U.S. is becoming more attractive for incremental investments.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
National Grid PLC1,083.80 GBX-0.77Rating

About Author

Travis Miller  is the director of utilities sector securities research at Morningstar.