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National Grid - doubling down on electric with WPD acquisition

Sophie Lund-Yates, Equity Analyst | 18 March 2021 | A A A
National Grid - doubling down on electric with WPD acquisition

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National Grid Ord 12, 204/473p

Sell: 994.20 | Buy: 994.30 | Change -12.40 (-1.23%)
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National Grid has announced plans to acquire PPL's Western Power Distribution electricity distribution assets, for an equity value of £7.8bn. National Grid has also agreed to sell PPL The Narragansett Electric Company (NECO) for £2.7bn, as part of the deal.

The acquisition will be funded primarily through short-term loan facilities, and is expected to occur within the next four months. The sale of NECO is expected to complete in the first quarter of 2022.

The group will also put its majority stake in National Grid Gas plc up for sale during the second half of this year.

The deal should increase the proportion of National Grid's electricity assets from 60% to 70%.

The shares fell 1.1% following the announcement.

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Our view

As the owner and operator of essential energy infrastructure across the UK and North-eastern US, National Grid is a vital business.

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. That translates into predictable revenues, low borrowing costs, and that feeds into what should be a relatively dependable dividend. One of National Grid's key attractions is its 6% dividend yield. No dividend is ever guaranteed, and yields are variable and not a reliable indicator of future income.

The regulatory environment can be a double-edged sword though as regulators have the final say over National Grid's profit potential. Ofgem has been a thorn in NG's side lately as it prepares the UK's grid for a surge in electricity needs. The regulatory body recently recommended that NG separate itself completely from managing the grid that it owns, to prevent a conflict of interest and ultimately keep electricity costs manageable for the British public.

It's unclear whether Ofgem will get its way, but with NG becoming an even larger electric monopoly, it could attract more regulatory attention. This isn't a clear cut risk yet, but is something to be mindful of.

The acquisition of Western Power Distribution means a higher proportion of National Grid's revenues and profits will come from electricity. It will also be the first time the group's owned electricity distribution assets in the UK, and will increase NG's total UK exposure to 70%. The group will effectively swap NECO, a US gas and electric business, and National Grid Gas (NGG) for WPD, so the transactions will have little effect on the balance sheet. Overall, the changes to the portfolio should cement NG's place at the centre of the UK's electricity revolution.

NG's using short-term, higher-interest "bridge" loans. That's ok as long as they're only used to bridge the gap between acquisition and sale. If the sale drags on longer than planned, it will increase the overall cost of the acquisition.

Still, we view the WDP acquisition as a positive step for NG. There's no doubt that electricity needs will ramp up in the long-term as demand for electric vehicles rises. NG is positioning itself for a lower-carbon future, which we view as a sensible move.

National Grid has the traditional pros of a utility, but also growth opportunities - a rarity for the sector. And we commend its willingness to pounce on shifting energy trends. But we'll be keeping a close eye on what this means for regulatory pressure.

National Grid key facts

  • Price/Earnings ratio: 14.4
  • 10 year average Price/Earnings ratio: 13.7
  • Prospective dividend yield (next 12 months): 6.0%

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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Acquisition Details

John Pettigrew, National Grid CEO said the deal, "will be transformational" and will help establish "National Grid as the leading electricity transmission and distribution operator in the UK".

Western Power is the largest electricity distribution business in the UK. WPD's total regulated assets are estimated to be worth roughly £8.8bn by the end of March 2022. In the financial year ending on 31 March 2020, WPD reported underlying profits of £750m. As at 28 February the group had £6.4m net debt.

NECO is an electricity and gas provider in the US. In the financial year ending 31 March 2020, NECO reported operating profits of $206m. The group's business has been valued at approximately $2.6bn.

National Grid Gas owns Great Britain's gas transmission network as well as National Grid Metering. The group's total regulated assets are estimated to be worth £6.3bn and Metering generated a £158m operating profit last year. Total underlying profits for National Grid Gas were £356m.

NG intends to pay for the acquisition using £8.3bn worth of financing. The proceeds of both the NECO and NGG sales will go toward paying off this new debt and the group may also issue new senior debt notes as well as hybrid shares if necessary.

The deal isn't expected to have any impact on the dividend policy.

Find out more about National Grid shares including how to invest

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.