Shares digital

Stability, visibility and yield are three reasons to plug into this utility

by Simon Keane

National Grid (NG.) 724.5p, Stop loss 650p

Shares summary

National Grid has visibility of earnings for the next five years and, as profit warnings pick up, investors will begin to value this visibility more highly.

Business:

Operator of electricity and gas distribution networks in the UK and the US

Vital stats:

Market value: £17.6 billion

Historic PE 2008: 10.3

Prospective PE 2009: 12.8

Prospective PE 2010: 12.2

Sector PE (next 12 months): 12.8

1-month relative strength: 11.2%

1-year relative strength: -2.1%

Yield 2009: 4.9%

Spread: 0.14%

As the biggest utility quoted in London, National Grid may be the most stable too. Operating in the highly regulated area of electricity and gas transmission, earnings of the £17.6 billion cap are unlikely to surprise on the upside but chances of downside disappointment are also minimal.

With a slowing economy and likely recession a spike in profit warnings is inescapable, so sentiment towards National Grid and other utilities will improve as investors prize stability. With the shares off 16% from their 863p year-high on 10 January the stock, at today’s 724.5p, trades at 12.6 times this year’s forecast earnings, a mere 9% premium to the FTSE 100’s 11.6 times. A multiple closer to the 16 the company was trading on in January is more appropriate.

There is also a juicy 4.9% dividend yield, which compares with 4.1% available from the FTSE 100. Management is committed to a progressive dividend policy, announcing in January it would increase the full-year dividend by 8% a year until 31 March 2012.

National Grid generates most of its earnings in the UK, where it has visibility of earnings from its gas distribution business until March 2013 and visibility from its electricity transmission arm until March 2012. Prices have been agreed with regulator Ofgem but that does not stop National Grid improving profitability by investing in its networks.

By tapping the bond markets for finance, National Grid plans to invest £16 billion over the next six years to March 2012, and it is likely any excess profits will be quickly returned to shareholders. Management, under the leadership of chief executive Steve Holliday, has a track record of returning cash and is currently more than half-way through a £2 billion share buy-back programme.

The current return of cash follows the re-organisation of the business over the past two years, which has involved the purchase of US power distribution and generation business KeySpan in 2007. Accompanying the bulking out of the American power business have been disposals of non-core assets such as the demerger of National’s wireless infrastructure operations and the sale of Basslink, which operated a 360km underwater power cable running between Australia and Tasmania.

More recently, the company has completed the sale of its Ravenswood power station in New York, the disposal of which was a regulatory condition of the KeySpan acquisition. There has been speculation National Grid could raise further funds by disposing of some of its huge land bank, although the current state of the property market makes an imminent move on this front unlikely.

Based on consensus estimates, earnings per share (EPS) are predicted to grow at around 6%-7% over the next couple of years from 54.3p this year to 58.5p in 2010 and then 62p in 2011. That kind of growth rate may not shoot the lights but knowing it is in the bag will be worth more to investors than some of the racier earnings forecasts found in other segments of the FTSE 100.