Although the return of risk appetite in recent times has seen investors opt for racier plays, the value of high yielding defensives can not be overstated. And given the paltry rates of interest available on the high street, a near 7% yield leaves National Grid shares well placed to find increasing favour in the months and years ahead.
The primary driver of National Grid’s ‘relative’ ordinary share price action over the opening half of 2009 was concern over the company’s debt position. However the announcement in May that the company’s safe and reliable earnings allowed it to raise £5 billion in debt last year (ruling out a cash call) and that it had agreed financing on 75% of the debt it will need to refinance this year, confirmed our suspicions that these concerns were overblown.
Encouragingly, to underscore the rude health in which the company finds itself, management have recently reiterated their commitment to their 8% dividend growth policy through to March 2012. And looking at the business model it is not difficult to see why.
With 95 percent on National Grid’s revenues regulated, the prospect of attrition in underlying earnings is highly limited. And a floor on profitability is something many companies can only wish for in the current environment.
Management has recently stated that the business is progressing in line with expectations and achieving current year targets will not pose any problems. Shareholders can look forward to a significant up tick in profitability in the company’s Electricity Distribution and Generation business whilst advances at the group’s Transmission business will also underpin earnings.
In the current climate it is very rare that increased US exposure is a source of earnings optimism. For National Grid though the emergence as one of the largest utilities companies stateside has achieved US$129 million in annual efficiencies, well ahead of the US$100 million forecast.
Given that price reviews in America take place less frequently than in the UK we are heartened by the group’s burgeoning presence stateside. Historically these reviews have resulted in the regulators requiring the utilities to pass on efficiency gains to customers in the form of reduced prices.
Commitment to a significant capital investment programme meanwhile will set the platform for further earnings gains (both in the UK and US) in the years ahead. The company is in the throes of a £3.4 billion plan for the current year which remains on target. Encouragingly, the majority of this year's £2.5 billion funding requirement has already been raised, with funding for around a further £400 million required in the current year.
From a financial perspective, National Grid remains on sound footing. Whilst debt has necessarily increased to £22.7 billion, interest cover remains solid in our view at just over 3 times. And what’s more, the company is set to deliver up to £350 million in annual cost savings on the back of improved procurement over the next three years.
Given National Grid’s improved standing it was no surprise to see credit rating agency Moody's recently upgrade Grid’s credit rating from 'negative' to 'stable'. Return of risk appetite or not, in our view such high quality defensives will continue to find increasing either way.
Furthermore, National Grid’s valuation offers significant comfort. The company trades on a prospective price earnings multiple of around 10 times for 2010 with a yield now approaching 7 percent.