Questor share tip: National Grid hits record highs

National Grid
919p
Questor says HOLD

Low interest rates boost profits

The UK’s largest listed utility company, National Grid [LON:NG] (click highlighted text for fundamental analysis), continues to enjoy a favourable economic backdrop to its activities. Record low interest rates are reducing costs on its debt pile, while steady inflation allows it to push through price increases to customers. The company said that pre-tax profits had increased by 12pc to £1.18bn during the first six months ended September. The main driver of the profit performance was cheaper borrowing rates. The utility reported an effective interest rate of 4.5pc during the first half, down from 5.3pc at the same stage last year. That might not sound like much, but on a net debt pile of £21.7bn the savings are £114m.

Defensive earnings

National Grid has stable revenue as it owns and operates gas and electricity distribution networks in the UK and some parts of the US, and then charges for the use of those networks, which creates a natural monopoly. The industry is closely regulated in the UK by Ofgem. National Grid reached an agreement with the regulator last year which set the framework for returns during the next eight years. With a more stable regulatory outlook the company increased the interim dividend by 1.5pc to 14.71p, going ex-dividend on November 20, and paid on January 7. Annual dividends had been increasing by about 8pc a year; now they track retail price inflation at 2.9pc this year.

Asset-backed shares

The value of the gas and electricity network is important to shareholders as it supports the share price. National Grid said its total assets in the UK and the US increased in value by £1bn on six months ago, to more than £39bn at the end of September. It invested £1.58bn in new gas and electricity infrastructure during the first half of the year and expects to spend up to £3.3bn for the full year. With such a large asset base delivering steady revenue, National Grid can fund a large debt burden, resulting in total borrowings of £25.6bn and net debt of £21.7bn at the end of September. A big chunk of this debt, 57pc, is at fixed low interest rates, the rest is RPI linked.

Shares at record highs

The last time Questor looked at National Grid we said investors should hold due to the favourable credit backdrop. The shares have increased more than 6pc since then and now trade on a price earnings ratio of 16.7 times, and offer a prospective dividend yield of 4.7pc guaranteed to rise with inflation. That leaves the shares at a slight premium to Centrica and SSE, on price/earnings ratios of 14.5 and 13.2 respectively, but they aren’t perfect comparisons. The shares are also at record highs and are overpriced when you consider the forecast earnings growth; as a guide, a utility should trade on around 12 times earnings. What you are getting here is surety of income, and for that reason we keep them as a hold.