Is National Grid plc A Safe Dividend Investment?

Not all dividends are as safe as they seem. What about National Grid plc (LON: NG)?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

nationalgrid1Is anything more attractive in the world of investing than the so-called defensive companies, particularly during uncertain times?

Judging by National Grid’s (LSE: NG) (NYSE: NGG.US) current valuation, it appears not — the firm seems alluring to investors like us, and we’ve driven the share price up by buying into the company.

Where’s the growth?

At today’s share price of 879p the gas and electricity transmission system operator trades on a forward P/E rating of around 15 for year to March 2016 and the dividend yield is down to about 5% . That valuation might not sound too high, but it’s rich compared to the firm’s recent history.

City forecasters predict an earnings decline of 17% this year followed by a 5% recovery the year after. Where’s the growth to justify National Grid’s higher valuation? The simple answer is that there isn’t any.

If we look at the firm’s trading figures, it seems clear that business is flat:

Year to March

2010

2011

2012

2013

2014

Net cash from operations (£m)

4,516

4,858

4,228

3,750

4,019

Operating profit (£m)

3293

3745

3539

3749

3735

Recent share price strength seems driven by valuation expansion and little more, so why is that happening?

Uncertain times

If we think of the investing landscape recently there are clues as to why National Grid, with its defensive qualities, has apparently become all the rage. Economic instability is wreaking havoc with whole sectors such as banking and supermarkets. Risk-averse investors will probably look to defensive sectors such as utilities and consumer goods to avoid the volatility.

The valuations of defensive firms like National Grid are on the rise. That strikes me as a situation that raises the stakes and increases the risk for new investors to the likes of National Grid. I’m worried that the valuation of defensive companies may be cyclical and that a lower valuation may be around the corner for National Grid. Perhaps that will happen as economic conditions become more benign and other investment options start to look less risky and, therefore, more appealing.

Competition for cash flow

It’s unwise to over-pay for any company. Even National Grid has its challenges despite its defensive appeal. Operations are capital-intensive, which requires the firm to run a high debt load. On top of that, governments keep the industry under close regularity scrutiny, which often require companies like National Grid to invest huge sums into their operations.

National Grid’s dividend competes with all of those things for the firm’s cash flow. In recent years, the dividend has risen, but with stagnant-looking earnings and cash flow, dividend cover from earnings is slipping. Adjusted forward earnings cover the payout for that 5% forward yield less than 1.3 times. If earnings and cash don’t start to grow dividend progression will need to halt. If that happens, the situation could become a catalyst for valuation compression, which could see investors’ patiently acquired income gains reversed by capital attrition as the share price slips.

What now?

National Grid would look like a safer dividend investment if the yield was higher and the P/E rating, lower. I’m concerned that, at this level, valuation compression could wipe out investor total returns down the road.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Kevin Godbold does not own shares in any of the companies mentioned in this article.

More on Investing Articles

Investing Articles

Could the JD Sports Fashion share price double in the next five years?

The JD Sports Fashion share price has nearly halved in the past five years. Our writer thinks a proven business…

Read more »

Bus waiting in front of the London Stock Exchange on a sunny day.
Investing Articles

If interest rate cuts are coming, I think these UK growth stocks could soar!

Falling interest could be great news for UK growth stocks, especially those that have been under the cosh recently. Paul…

Read more »

Investing Articles

Are these the best stocks to buy on the FTSE right now?

With the UK stock market on the way to hitting new highs, this Fool is considering which are the best…

Read more »

Petrochemical engineer working at night with digital tablet inside oil and gas refinery plant
Investing Articles

Can the Centrica dividend keep on growing?

Christopher Ruane considers some positive factors that might see continued growth in the Centrica dividend -- as well as some…

Read more »

Smiling family of four enjoying breakfast at sunrise while camping
Investing Articles

How I’d turn my £12,000 of savings into passive income of £1,275 a month

This Fool is considering a strategy that he believes can help him achieve a stable passive income stream with a…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

2 top FTSE 250 investment trusts trading at attractive discounts!

This pair of discounted FTSE 250 trusts appear to be on sale right now. Here's why I'd scoop up their…

Read more »

Smiling young man sitting in cafe and checking messages, with his laptop in front of him.
Investing Articles

3 things that could push the Lloyds share price to 60p and beyond

The Lloyds share price has broken through 50p. Next step 60p? And then what? Here are some thoughts on what…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

£1,000 in Rolls-Royce shares a year ago would be worth this much now

Rolls-Royce shares have posted one of the best stock market gains of the past 12 months. But what might the…

Read more »