I’m looking at some of your favourite FTSE 100 companies and examining how each will deliver their dividends.
Today, I’m putting utilities giant National Grid (LSE: NG) (NYSE: NGG.US) under the microscope.
At the end of 2007, National Grid accepted regulator Ofgem’s price-control proposals for the five years to March 2013. Shortly afterwards, the company announced a one-off dividend increase of 15% and thereafter a new dividend policy of 8% growth a year to run until March 2012. The new policy reflected “the Board’s confidence in the Group’s growth prospects”.
The company delivered the targeted dividend growth, but not without the hiccup of a deeply-discounted rights issue during 2010 to raise £3.2bn from shareholders — equivalent to about four years’ worth of dividends.
During 2012, National Grid announced a new one-year policy of 4% dividend growth — on which it delivered — while awaiting new price-control proposals from Ofgem, which would run for eight years to March 2021.
Current dividend policy
National Grid accepted Ofgem’s proposals, and announced a new dividend policy during March this year:
“The new policy will aim to grow the ordinary dividend at least in line with the rate of RPI inflation each year for the foreseeable future”.
National Grid has a near-monopoly over the networks that deliver gas and electricity across the UK, and also has power operations in the US. The trade-off for regulatory stability is that the company is subject to price controls and oversight that have the effect of limiting profits.
However, there are several ways utilities can enhance shareholder returns. The two most significant are: first, by increasing debt — ‘gearing’ — the idea being to make profits over and above the costs of borrowing the money; and, second, by having non-regulated businesses alongside their regulated operations.
Non-regulated businesses can be a double-edged sword. It’s not unknown for utilities with such operations to see their overall earnings hurt if the riskier non-regulated business fails to perform. However, there’s little to worry about here for National Grid: the company’s non-regulated activities, such as metering, account for less than 5% of revenues.
Debt is a risk for National Grid. It’s not the debt per se, but how credit-rating agencies rate the company as a debtor that’s crucial. A downgrade from the agencies would mean National Grid would have to pay more interest to borrow money.
Indeed, it was a threat to National Grid’s credit status that led to the rights issue during 2010. The company needed to raise cash from shareholders “to meet our investment needs over the coming years, whilst maintaining our current single A credit ratings”.
In this context, it can be noted that there is a proviso to the current dividend policy of growing the dividend at least in line with RPI inflation:
“Any dividend increases above inflation will need to be supported by sustained outperformance and to have no impact on long-term credit ratings”.
Delivering the dividend
The board has misjudged the company’s capital requirements in the recent past — hence, the rights issue — so, there’s a black mark against management there. On the positive side, it’s arguable that management is unlikely to make the same mistake again in the foreseeable future. The current dividend policy, which could be met by dividend growth pegged to inflation, is markedly more conservative than the policy of 8% growth that ran until 2012.
I’d suggest that annual dividend growth in line with inflation isn’t a bad deal these days, especially when National Grid is offering a forecast starting income of 5.7% at a current share price of 759p.
I can tell you that the Motley Fool’s chief analyst believes National Grid is not only the UK’s top income stock, but also that fair value for the shares is 850p compared with the 759p investors can buy at today.
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> G A Chester does not own any shares mentioned in this article.