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National Grid-profits to meet top end of guidance

Sophie Lund-Yates, Equity Analyst | 18 November 2021 | A A A
National Grid-profits to meet top end of guidance

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National Grid Ord 12, 204/473p

Sell: 1,049.00 | Buy: 1,049.50 | Change 28.00 (2.74%)
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Underlying operating profit rose 47% to £1.4bn, with £257m coming from newly purchased Western Power Distribution. Excluding this, profits rose 20%, as the group recovered from last year's covid disruption.

The group will pay an interim dividend of 17.21p per share, compared to 17p per share last year.

National Grid said that the positive start to the year means it expects full year earnings per share to be "significantly above the top end of our 5 - 7% range".

The shares were broadly unchanged following the announcement.

View the latest National Grid share price and how to deal

Our view

National Grid is making good on its efforts to plant itself at the centre of the electric revolution. That's courtesy of the early completion of a second UK/France network and Western Power Distribution now officially under its umbrella. The result was a buoyant first half.

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 (NG) 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 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 is the first time the group's owned electricity distribution assets in the UK, and increases NG's total UK exposure to 70%. The group plans to 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.

WPD added £13bn to overall net debt and 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. Management plans to offload both NECO and NGG by summer 2022, but a lot can happen in six months -- it's a risk worth keeping an eye on.

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: 15.4
  • 10 year average Price/Earnings ratio: 14.0
  • 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

Underlying operating profit in UK Electricity Transmission rose 13% to £552m, driven by favourable new regulatory pricing. The division is expecting revenue to rise as new price controls come into effect but will be offset by higher spend on IT and cyber.

UK Electricity Distribution now includes Western Power Distribution and contributed £257m to underlying operating profits.

The timing of regulatory changes, and significant under-collection last year meant underlying operating profits at UK Electricity System Operator (ESO) rose to £49m from £37m. Excluding the timing tailwind, the revenue increase was partly offset by rising costs and depreciation. Revenue in the division is expected to rise by about £70m under new price controls, but should be offset by increased costs and depreciation charges.

New England saw underlying operating profits rise 25% to £247m. The division expects revenue to gain $50m due to rate increases, while lower levels of covid-related non-payment should bring bad debts down. The sale of the Rhode Island business is on track to complete in March 2022.

New York underlying operating profit fell 24% to £141m as environmental provisions and storm costs offset rate increases. Full year revenue is seen rising by £170m, but will be offset by rising costs. Covid-associated bad debts are expected to decrease by around £100m.

NGV & Other saw adjusted operating more than double to £161m, reflecting contributions from the IFA2 France/UK connected network and gains from the NG Partners investment portfolio. The group's first France/UK connected network, IFA1, was damaged by a fire, offsetting it's revenue increase during the period. The North Sea Link, the France/UK connected network and rising prices are all expected to drive full year operating profits £200m higher.

UK Gas is now classified as 'held for sale' and expected to be sold by summer 2022.

Capital expenditure rose 15% to £2.8bn during the half as new costs associated with WPD, together with increased spending in UK Electricity Transmission outpaced reduced investment in the now operational France/UK network.

The WPD acquisition was the primary reason net debt rose by £13bn to £41.5bn. Excluding the impact of the acquisition and the business held for sale, the group had a free cash outflow of £360m an improvement from last year's outflow of £438m.

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.