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National Grid - results in-line, focus remains on the future

George Salmon | 16 May 2019 | A A A
National Grid - results in-line, focus remains on the future

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National Grid Ord 12, 204/473p

Sell: 903.80 | Buy: 904.40 | Change 2.20 (0.24%)
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National Grid's operating profits fell 18% in the year to 31 March, but after adjusting for timing and exceptional items (including the cost of labour disputes in the US, restructuring and nuclear impairments) underlying profits were down just 1.9% to £3.4bn.

The final dividend is set to increase 3.07% to 31.26p per share.

The shares were unmoved on the morning of the results.

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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.

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

In return for investing billions maintaining and upgrading its infrastructure, regulators allow National Grid to earn a reasonable profit, with the potential to earn more if it exceeds targets. This results in predictable revenues and low borrowing costs, and underpins the group's ability to pay regular dividends.

National Grid's aiming to grow the full year dividend by at least the rate of RPI inflation, and the shares currently offer a prospective yield of 5.9%.

We think this remains the group's main attraction, but there are a few clouds on the horizon.

The first is regulation. Ofgem has proposed cutting the allowed rates of return for its next 5 year cycle, starting in 2021. National Grid is lobbying the regulator, but the current proposals would make continual dividend increases harder to achieve.

There's also the looming threat of nationalisation. Labour have been clear that one of the first things they'd do after getting the keys to number 10 would be to nationalise the utilities. Of course, whether that's right for the country or not is a separate question, but it could see investors out of pocket.

The final worry concerns interest rates. In recent years National Grid's income-paying potential helped it become a popular destination for bond investors seeking higher yields in a low-interest rate world. But rates here and in the US starting to rise. That means the tailwind the group has enjoyed is starting to turn into a headwind.

The positive for income-seeking investors is that while higher rates would likely impact the share price, they shouldn't affect the dividend.

And those concerned about the income prospects should take heart from the fact that, in our view, any dividend policy changes as a result of Ofgem's proposals are likely to be minor rather than major. The fact National Grid is confident it can take tens of millions out of the cost base from efficiency measures, both here and in the US, should bring further assurances.

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Full year results

The fall in group underlying operating profit was driven by a 32% drop at UK Gas Transmission, to £341m. This was primarily caused by the group refunding revenues from the mothballed Avonmouth project dragging net revenue down 17% to £707m. Adjusted regulated asset value (RAV) rose 3.3% to £6.2bn.

UK Electricity Transmission net revenues rose 6% to £2bn, due to inflation indexing and outperformance rewards from the regulator. With this increasing faster than costs, underlying profits rose 4% to £1.1bn.

RAV rose 3.8% to £13.5bn, due to asset additions of £967m, inflation adjustments and increased efficiency more than offsetting depreciation.

In the US, net revenue rose 2% at constant exchange rates to £5.6bn, as new regulatory rate agreements came into effect. However, higher regulated and other costs, plus an increased bad debt expense, saw underlying operating profits fall 10% to £1.6bn. The asset base rose 8% at constant currency to £19.5bn.

The Ventures and Other business delivered a 13% increase in operating profit, reflecting lower set-up costs. The group continues to invest in the division, with capital spend on interconnectors doubling to £252m.

Despite the group's increased asset base, gearing (which compares net debt to regulated and other capital) rose from 65% to 66% as net debt increased from £23bn to £26.5bn.

In 2019/20, National Grid expects net revenues to grow in each of the three main divisions.

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