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National Grid - on course for the full year

Nicholas Hyett | 14 November 2019 | A A A
National Grid - on course for the full year

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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: 1,049.00 | Buy: 1,049.50 | Change 28.00 (2.74%)
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First half underlying operating profits fell 0.5% at constant currency, to £1.3bn, although National Grid's US business continues to perform strongly.

The group announced an interim dividend of 16.57p per share, 3% ahead of last year.

The shares rose 1.4% 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.

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 sensible.

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 5.6%. 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 a looming threat of nationalisation. Labour has said that if they get the keys to number 10, taking back utilities could be on the cards. Of course, whether that's right for the country or not is a separate question, but it could well leave investors out of pocket.

Our 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. Rates are still low at the moment, but if we start to see increases, the appeal of dividend paying stocks like National Grid is reduced.

The positive for income-seeking investors is that while higher rates would likely impact the share price, they shouldn't affect the dividend. Those concerned about the income prospects should take heart from the fact that, in our view, any dividend policy changes as a result of regulatory change are likely to be minor. 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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Half year results (constant currency figures used)

In the US, underlying operating profits rose 16% to £525m. Higher revenues from an increase in rates and lower storm costs contributed to the rise, but were partly offset by increased depreciation costs.

UK Electricity Transmission saw operating profits rise 5% to £583m, reflecting inflationary increases in revenues. National Grid expect profits to be slightly higher in the second half and the group still expects to deliver Return on Equity (ROE) outperformance of 2-3 percentage points.

Operating profits in Gas Transmission fell 27% to £66m, the result of lower net revenues from reduced capacity on the gas network. ROE is still expected to be around the allowed level for the full year.

In the Ventures business all three interconnector projects remain on track. Operating profits in this business fell 39% to £127m.

National Grid increased capital investment by 24% to £2.7bn in the first half. That reflects upgrades to the US network, maintenance spending on existing assets, and the acquisition of Geronimo, a US based wind and solar developer, for £209m. For the full year capital investment is expected to be near £5bn contributing to annual asset growth at the top end of the 5 - 7% range.

Over the first six months net debt increased by £1.3bn to £27.8bn. Exchange rates were the key contributor to the rise and, together with a change in how National Grid accounts for leases, were only partially offset by the £2bn sale proceeds from Cadent.

National Grid remains on track to deliver £50m cost savings in the UK and $30m in the US.

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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.