Questor: National Grid’s pivot back to electricity has sparked our interest in its net-zero future

Environmental, social and governance (ESG) investing has become increasingly popular over recent years. In fact, a record £480bn flowed into ESG-focused funds in the year to Nov 30 2021. This was a vast increase on the £211bn inflow recorded in 2019.

A significant proportion of capital allocated to ESG-related investments is focused on renewable energy assets. For instance, many investors now hold units of investment trusts focused on solar or wind energy assets. Meanwhile, a sizeable portion of their stockholdings are likely to be energy companies seeking to pivot from fossil fuels to renewable assets.

While this column believes that investing in renewable energy assets can be worthwhile, it also views National Grid, which transmits the clean electricity they produce, as an oft-overlooked opportunity to benefit from the energy transition.

Indeed, the company is in the process of pivoting to electricity assets. It recently completed the acquisition of Western Power Distribution (WPD), which is the UK’s largest electricity distribution network operator. Alongside the disposal of its Rhode Island business and plan to sell a majority stake in National Grid Gas, the proportion of the firm’s asset base in electricity is expected to increase from around 60pc to approximately 70pc.

This positions the company for long-term growth in an era where electricity usage is forecast to rise significantly. For example, demand for electricity in the UK is forecast to increase by 70pc within the next 30 years as the Government’s net-zero ambitions prompt individuals and businesses to shift their consumption away from fossil fuels. 

In Questor’s view, National Grid’s monopoly position means it could be a simple and relatively low-risk means of capitalising on that growth opportunity. Indeed, the firm’s acquisition and disposal activity will result in a business that continues to offer significant geographical and regulatory diversity, since around 40pc of its asset base will be located in the US.

Meanwhile, the firm expects to deliver a compound annual growth rate in underlying earnings per share of 5-7pc between 2021 and 2026. It intends to strengthen its return prospects through a reorganisation that has prompted the implementation of a revised operating model. It is also introducing a major efficiency programme that will target cost savings of at least £400m per annum by the end of a three-year implementation period.

Separately, the company’s business model could be suited to the current economic environment. Having recently commenced a new five-year regulatory period in electricity transmission, the firm is aiming to grow its dividend at an annual rate that is at least equal to the consumer prices index including owner occupiers’ housing costs (CPIH) in the coming years. As an aside, CPIH is the Office for National Statistics’ preferred inflation measure.

Since the Bank of England forecasts a further rise in inflation, which currently stands at 4.8pc (CPIH), National Grid’s dividend growth policy, when combined with its 4.5pc yield, could become increasingly appealing to income investors during a period where rapid price rises are quickly becoming the norm.

Moreover, its relatively stable business model and defensive characteristics may attract investors in an era where geopolitical risks and the prospect of stagflation have prompted heightened stock market volatility.

Indeed, those factors, as well as the firm’s strategy shift, have contributed to a change from our previous advice to sell National Grid in November 2020. Then, concerns surrounding regulatory and political risks, as well as the company’s high debt levels, convinced this column to look elsewhere for return opportunities.

While those threats may not have disappeared entirely, the company’s decision to pivot to electricity assets ahead of likely strong growth, its dividend growth potential during an era of high inflation and defensive characteristics amid heightened stock market volatility mean that its risk/reward profile is now attractive on a long-term view.

Questor says: buy

Ticker: NG

Share price at close: £10.93

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