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National Grid - half year profits hurt by COVID-19 costs

Nicholas Hyett, Equity Analyst | 12 November 2020 | A A A
National Grid - half year profits hurt by COVID-19 costs

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National Grid Ord 12, 204/473p

Sell: 931.50 | Buy: 931.70 | Change 4.70 (0.51%)
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National Grid's underlying operating profit for the first half fell 12% to £1.1bn, primarily reflecting the impact of COVID-19 related costs.

The group continues to expect COVID-19 to reduce operating profits by around £400m for the full year, mostly due to the US business. Cash flow is expected to fall by £1bn. Management says it is "confident" it will be able to recoup most of its US costs through regulatory mechanisms.

The group declared an interim dividend of 17.0p per share, up from 16.57p this time last year

The shares fell 1.5% following the announcement.

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Our view

It's at times of crisis that the usually unexciting world of utilities comes into its own. National Grid is no exception. That's not to say the pandemic has had no impact, as provisions for bad debts and lost revenue are expected to cost the group a fair amount this year. However, a large chunk of this should be recoupable thanks to the group's arrangements with regulators.

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.

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 usually results in predictable revenues and low borrowing costs, and underpins the group's ability to pay regular dividends.

However, National Grid is currently negotiating with Ofgem over the next details of the next period. Ofgem's proposals in July were disappointing, and caused credit ratings agencies Moody's and Standard & Poor's to put the group on a negative outlook. Essentially, Ofgem's proposal would have meant lower returns for National Grid, which management is keen to avoid. We expect an update soon, but still don't know how exactly this will shake out. 

National Grid's US operations provide some diversification, so the group isn't dependent on the whims of just the UK's regulator. However, storms are continually disruptive and expensive, so the division isn't devoid of its own problems. Overall, we think the diversification is a positive though.

Heavily regulated monopolies have tended to be relatively predictable, and this means they should be able to afford to pay reasonable dividends, which is what has usually attracted investors to utilities. While the current spat with Ofgem is unfortunate, these happen from time to time. We think National Grid's dividend should be sustainable, although nothing is guaranteed.

National Grid key facts

  • Price/Earnings ratio: 17.5
  • 10 year average Price/Earnings ratio: 13.5
  • Prospective dividend yield (next 12 months): 5.2%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Half year results (figures are underlying)

Management estimates that COVID-19 costs amounted to £117m in the half. This included an increase in bad debt provisions of £56m, a revenue shortfall of £41m and direct costs of £20m.

In the US, underlying operating profits fell 22% to £403m. Storms reduced operating profits by £61m, and National Grid expects the full year storm costs of around $100m. Capital investment rose £75m to £1.6bn, as higher electricity spending offset lower spending in gas.

UK Electricity Transmission saw operating profits fall 10% to £524m. Capital expenditure rose £77m to £548m, mainly due to the London Power Tunnels 2 and Hinkley Point projects.

Operating profits in UK Gas Transmission rose 64% to £108m. Capital spending fell £82m to £85m, reflecting less work at two gas terminals, the completion of a tunnel for the Feeder 9 pipeline and lower emissions work.

Management said they were "disappointed" with the draft regulatory proposals for RIIO-2 from Ofgem. Management said the proposals would lead to "lower allowed capital expenditure, lower returns, limited incentives, and extensive use of uncertainty mechanisms". Ofgem has also proposed a £556m clawback from T1 price controls and business plan incentive penalty of £93m. Negotiations are ongoing.

In the Ventures business operating profits fell 12% to £112m, and capital investment fell from £496m to £286m. Management said "significant progress" had been made on the interconnectors portfolio.

Net debt stood at £30.1bn at the end of September, and management expects it to rise a further £1.5bn in the second half. Credit ratings agencies Moody's and Standard & Poor's moved National Grids outlook to negative following the RIIO-2 announcement.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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.