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National Grid - building its asset base

George Salmon | 17 May 2018 | A A A
National Grid - building its asset base

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No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

National Grid Ord 12, 204/473p

Sell: 996.00 | Buy: 996.10 | Change -10.60 (-1.05%)
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In the year to 31 March, National Grid's operating profit fell 8% to £3.5bn as a result of adverse timings and major storms in the US. Excluding these effects, profit was up 6% at constant exchange rates.

The full year dividend rose 3.75% to 45.93p per share. National Grid will continue to target paying dividend increases at or above the rate of RPI inflation.

The shares rose 1.1% on the news.

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Our view

Demand for what National Grid does isn't going to go away this side of the next Dark Age. As the owner and operator of essential electricity and gas infrastructure across the UK and north-eastern US, the company is vital to keeping the lights switched on and homes and businesses heated.

Unsurprisingly, its markets are tightly regulated.

Each year it's required to invest billions on maintaining and upgrading its infrastructure. In return, it's entitled to earn a reasonable profit, with the potential to earn more if it exceeds regulatory targets. This business model results in highly predictable revenues and low borrowing costs, both of which underpin the group's ability to pay regular dividends.

National Grid's aim is to grow the full year dividend by at least the rate of RPI inflation, and the shares currently offer a prospective yield of 5.6%.

While the company is stepping up capital expenditure and growing the US asset base, the potential for rapid growth is limited. To be honest though, utilities were never meant to be anything but steady.

Its defensive qualities proved attractive amid economic uncertainty, while the income potential means it's proven a popular destination for bond investors seeking higher yields in a low-interest rate world.

When nudging rates back up to 0.5%, the Bank of England guided expectations towards a slow and steady approach to future rate increases. Given the fragile state of the UK economy, we see no reason why this wouldn't be the case.

However, investors should nonetheless be wary. A rapid rise could hit the share price by pushing up the relative appeal of other income-generating assets like bonds.

We don't see the dividend coming under pressure any time soon, but if conditions change and rates start rising faster than expected, the share price might.

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Full year results (at constant exchange rates)

National Grid spent £4.3bn on maintaining and growing the asset base. This spend was 14% higher than the prior year, with the majority of the extra spend taken up by the US business and the group's Ventures portfolio. Following this spend, the value of the group's regulated asset base rose 6% to £36bn.

Continued UK outperformance means the group has generated around £540m of customer savings in the first five years of the current regulatory period. The group is in discussion with Ofgem about the next period, starting 2021.

During the period, the group announced the sale of an option agreement on its remaining 25% stake in Cadent, the Grid's Gas Distribution business. The sale should generate around £1.2bn.

Looking ahead, National Grid expects its asset base to grow at the top end of the previous 5-7% target range in the medium term, with the US a focus following the agreement of new regulatory conditions. Higher net revenue from UK electricity distribution and US business is expected to offset a lower take from UK Gas distribution (excluding the impact of timing) in 2018/19.

Having risen £3.7bn to £23bn in the year, continued investment is expected to take net debt to around £25.5bn next year.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.