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National Grid - Covid impact lower than feared

William Ryder, Equity Analyst | 20 May 2021 | A A A
National Grid - Covid impact lower than feared

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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: 1,073.00 | Buy: 1,074.00 | Change 20.00 (1.90%)
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National Grid's full year underlying operating profit fell 3% at constant currency to £3.3bn as higher costs offset higher revenues.

The pandemic reduced underlying operating profit by roughly £355m and cash flow by around £600m, compared to expectations of £400m and £1bn respectively.

The board has declared a final dividend of 32.16p per share, bringing the full year payment to 49.16p, up 1.2% year-on-year.

The shares rose 1.0% 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 feeds into what should be a relatively dependable dividend. 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 NG recently acquired Western Power Distribution (WPD), making it an even larger electric monopoly, which could attract more regulatory attention. This isn't a clear-cut risk yet, but is something to be mindful of.

The WPD acquisition 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 should 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 to fund the purchase. 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: 15.3
  • 10 year average Price/Earnings ratio: 13.8
  • Prospective dividend yield (next 12 months): 5.4%

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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Full year results

UK Electricity Transmission saw underlying operating profit fall 4% to £1.1bn, reflecting flat net revenues after timing adjustments and higher costs. Management expects revenue to rise by around £140m next year, but for cost increases, including cybersecurity costs, to more than offset this. The division recorded a 13.9% return on equity, up from 13.5% last year.

Underlying operating profit from UK Gas Transmission rose 9% to £438m, reflecting higher revenue and lower underlying costs. Net revenue is expected to rise by £40m next year, but higher costs will offset this. Return on equity fell from 9.8% to 9.6%.

The US Regulated operations recorded a 9% fall in underlying operating profit to £1.5bn. This reflects a £223m increase in net revenue which was partially offset by increased costs, including higher bad debt provisions. Return on equity fell from 9.3% to 7.2%.

National Grid Ventures and Other Activities contributed £237m to operating profit, down 2% year-on-year.

National Grid generated £4.6bn in cash from continued operations, and after cash capital expenditure and investments of £4.9bn and dividends from joint ventures, the business saw a cash outflow of £222m. Cash generation was down due to lower revenue, adverse timing, higher costs and the Covid-19 pandemic. Net debt currently stands at £28.5bn, down from £28.6bn last year.

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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.