National Grid is worth considering as a core energy holding.
National Grid (LSE: NG) is one of those boring but safe utility investments that generates a rather tasty dividend. If you believe, as I do, that the recent rally is a sucker's rally, its defensive qualities will have obvious appeal.
So what exactly does it do?
National Grid operates the power transmission backbone of the UK, as it runs the electricity wires across Great Britain and Northern Ireland.
National Grid Gas, previously known Transco and formerly part of British Gas, runs the UK's gas pipe network. It also owns the network in England and Wales -- although the Scottish network is owned by other parties.
In addition, the company also owns generator Niagara Mohawk in the US.
Results
Consensus forecasts for the year ending 31 March 2010 are that it will deliver pre-tax profits of just over £2bn (2009: £1.4bn) on revenues of approximately £15bn (2009: £15.6bn). National Grid's market cap is around £15bn, giving a forward P/E of about 11. A full-year dividend of 38.5p is forecast, suggesting a prospective yield of 6.3%.
Although dividend cover is only 1.5 times, there seems little likelihood of it coming under any pressure despite the company's enormous debts of £22.7bn. This is £5bn higher than last year's debt figure, due to the strengthening of the dollar and the need to fund its ongoing capital expenditure programme (some £3bn a year).
There were fears National Grid was going to have to have a rights issue in order to pay down some of its debt. These fears seemed to subside in July with the upgrade from the credit-rating agency Moody's to 'stable' from 'negative'. This should make easier and cheaper to refinance its debts in future. Since then, National Grid's share price has risen steadily to its present level of 615p, but this is still a long way from its recent high of 735p.
The future
Given the strategic importance of the grid to the UK's efforts to cut carbon emissions, you can expect this regulated monopoly to be allowed to charge more to customers in the future. This will increase its margins and allow it to fund the investment required for renewable energy sources. Ofgem, the energy regulator, recently said it will allow an 'assured regulatory environment' for £1bn of investment for this very reason.
Of course, the presence of a regulator provides one layer of uncertainty. A new set of regulatory controls is due in 2012 and there's a review of the way Ofgem regulates, which could produce profound changes. So you'd need to be comfortable with these risks before investing.
However, given the pressures on governments to cut carbon emissions and make efficiency savings, the likelihood is that there will be further relaxation of the price controls in order to ensure crucial investments are made.
National Grid does half its business in the north eastern United States, distributing energy to 3.4m homes, and is keen to benefit from state and Federal incentives to increase energy efficiency, which could bring in tens of millions of dollars.
So, to sum up, future profit growth is expected to come from three main areas:
- cutting costs across the business;
- growth in turnover in its UK and US businesses coupled with higher margins; and
- reducing the cost of servicing its debts.
Its next set of figures are due out on 19 November, so I'll be looking at these with interest. I'd also be curious to see what other Fools think of this share.
More from Chris Menon:
