Should National Grid plc and Wm Morrison Supermarkets plc be broken up?

Roland Head explains why National Grid plc (LON:NG) and Wm Morrison Supermarkets plc (LON:MRW) could come under pressure to be split up.

| 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.

MPs think that National Grid (LSE: NG) should be broken up. Last week’s recommendation by a parliamentary committee echoes a similar call last year from energy secretary Amber Rudd.

The argument in favour of breaking up National Grid is that there are potential conflicts of interest within the firm’s UK operations. National Grid is responsible for organising back-up power when UK power stations can’t meet demand. One way of doing this is by importing additional electricity through the interconnector with France, which National Grid also owns.

The interconnector generated an operating profit of £123m last year, up 19% on 2014. While National Grid says it has safeguards in place to prevent any conflicts of interest, critics are concerned.

I suspect shareholders will also be concerned by talk of a break-up. This supposedly dull utility stock has delivered a total return of 100% over the last five years. That’s the result of a 65% share price gain plus dividends totalling 35% of the shares’ value at the start of June 2011.

Should you sell?

I wouldn’t rush to sell my National Grid shares. Calls for a break-up are likely to face determined opposition from the company. It may not happen.

A more realistic concern is that much of the firm’s share price growth during the last five years has been the result of an increase in valuation, rather than rising earnings.

The group’s post-tax profits have only risen by an average of 3.7% per year since 2011. What’s really changed is that National Grid shares were trading on a P/E of about 11 in 2011. They now trade on a 2016 P/E of 16. This has pushed the firm’s dividend yield down from 6.2% in 2011 to 4.4% today.

I’d argue that National Grid’s yield may become less attractive if it falls much further. I believe share price growth is now likely to slow.

A unique advantage?

Unlike other UK grocery giants, Wm Morrison Supermarkets (LSE: MRW) produces much of its own food. The group’s Farmers Boy business produces fresh produce for Morrisons stores. It generated a profit of £64.9m for the year ending 1 February 2015, the most recent period for which accounts are available.

This vertically integrated business model might seem old fashioned, but I believe it’s one of Morrisons’ most attractive assets. Whereas Morrisons’ operating margin was just 2.1% last year, Farmers Boy reported a 9.1% operating margin in 2014/15. Morrisons’ food business clearly helps to support the firm’s profits, dividends and valuation.

Of course, another way of looking at things is that Morrisons could buy the same food from other suppliers for much the same price. Instead of holding on to Farmers Boy, the group could sell it and return the funds to shareholders.

Based on last year’s profit of £64.9m, I estimate Farmers Boy could be worth about £850m on a fairly conservative 13 times earnings multiple. This would equate to about 36p per share for shareholders — around 20% of the current share price.

Should Morrisons sell? Absolutely not, in my view. I believe Farmers Boy gives it a unique advantage over its peers in terms of marketing and financial performance. This is one of the reasons why I believe the shares remain attractive for long-term buyers.

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.

Roland Head owns shares of Wm Morrison Supermarkets. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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 »