UK Edition
Rather annoyingly, shares in National Grid have fallen by 18pc from their spring high, but the slide appears to be related to wider macroeconomic issues rather than company-specific ones.
So we can stay calm and continue to nurture a position in the utility, especially as our lowly entry price of almost a year ago means we are still in the black.
Last week’s first-half trading update contained nothing untoward, although the greater than normal weighting towards the second half of the fiscal year to March 2024 does need watching, as this can mean a company still needs a few things to turn out well for analysts’ earnings estimates to be met.
Those analysts already expect changes to the Government’s capital allowance regime to hit earnings growth in the year to March 2024, when underlying earnings per share could come in slightly lower than in the 2023 financial year.
Even then, 45pc of the “regulatory asset value” of the FTSE 100 company’s electricity and gas transmission networks lies in America, so the National Grid is far from wholly exposed to regulatory or political developments in Britain (not least the Labour conference’s vote yesterday in favour of nationalisation of its UK assets).
No, the share price tumble seems unrelated to regulation, politics or the underlying performance of the assets. Instead, the problem is central bank interest rates, how they in turn influence government bond yields and how they in turn can affect how stock markets behave and how shares are valued.
For much of the past decade, bullish investors have argued that share prices should rise because record low interest rates and quantitative easing resulted in record low government bond yields.
Paltry returns on cash and bonds translated into “there is no alternative”, in that income-starved investors had to turn to riskier assets such as shares if they were to rake in some much-needed yield.
But now the Bank Rate is 5.25pc, the yield on the benchmark 10-year UK government bond or gilt is 4.5pc, banks are offering interest rates of about 6pc on some accounts and it is easy to see why investors might lean toward these alternatives.
Investors must consider the role of inflation and the scope for real, inflation-adjusted returns in each case, and the potential for capital appreciation may still swing some towards the stock market.
But at a time of political and economic uncertainty, and when the London stock market remains out of favour on the global stage, it is easy to see why the yield-hungry may seek the more predictable options of cash or bonds over shares.
Such a rationale appears to be taking a particularly heavy toll on “bond proxies” such as shares in utilities. Utilities do not grow their earnings quickly, as demand is fairly stable and returns are regulated.
As a result, their shares tend to offer plump yields to attract buyers and compensate them for the risks involved with holding the stock
But higher government bond yields make bond proxies less attractive on a relative basis, as government debt offers less risk than shares (there is much less chance of a bond default than there is of a dividend cut). Utility shares are weak not just in Britain but in America too, and this supports our view that the weakness in National Grid is part of a wider trend and not a signal of any unexpected woes at the company itself.
In the meantime, the utility offers a 6.1pc dividend yield, which still looks attractive and will appeal all the more if inflation continues to moderate.
The relatively predictable nature of National Grid’s earnings and cash flows is likely to stand out should the economy start to slow and more cyclical stocks suffer profit forecast downgrades.
And eventually the Bank of England will cut interest rates, either in response to economic weakness or because it is meeting its inflation goal, or because something unexpected is going wrong.
Financial markets may be taking fright of policymakers’ rhetoric that interest rates may stay higher for longer than expected, but a look at the long-term chart of the Bank Rate suggests that long periods of elevated borrowing costs are rare indeed, because the pressure created by tighter monetary policy always tells in the end.
Then the Bank has to ease. And any sign of lower returns on cash and government bonds could, in turn, highlight again the appeal of the yields offered by utilities.
National Grid remains a sound income option within a balanced portfolio.
Questor says: hold
Ticker: NG
Share price at close: 948.4p
Russ Mould is investment director at AJ Bell, the stockbroker
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