In the last 52 weeks of trading, National Grid (LSE: NG) (NYSE: NGG.US) stock has been valued between 711p and 897p, and it currently trades at 834p. A fair value of 1,000p is not overly optimistic, but it comes with caveats.
Balance Sheet
National Grid reported total assets of £52.3bn as of 31 March 2014.
Cash on hand and equivalents and short-term investment totalled £6.8bn, or 106p per share on a fully diluted basis. Receivables stood at £2.8bn, for about 76p per share.
Inventory and other currents assets are worth 18p a share, while property, plant and equipment (PP&E) have a book value of £37bn, or 996p a share. Applying a 20% to 30% discount to PP&E, which appears reasonable in a base-case scenario, these assets are valued between 697p a share and 797p a share.
It Looks Good
Goodwill and intangibles are seldom easy to gauge. In this conservative analysis, these assets, as well as other long-term assets, are worth zero rather than 201p per share, which is their book value.
According to this approach, the value of National Grid stock ranges between 897p and 997p, for a 7% to 20% upside to its current price. Earlier this week, before National Grid stock started trading ex-dividend, its valuation hit a record high of 896p.
Well, this is the bit to like — yet how assets are financed is just as important as the value and the quality of the assets themselves.
Working Capital, Cash Flow And Leverage
Not only positive working capital (+£158m) means that National Grid can’t self-finance its operations, but its balance sheet carries a huge amount of debt. Its net debt pile of £23bn is almost five times its adjusted operating cash flow. This is high by any standards.
On average, National Grid has spent roughly £1.03bn annually over the last six years in interest payments. Since 2011, these costs have dropped by £200m a year, and they could diminish significantly if the company had a more balanced capital structure. One option, for instance, would be to redeem some of its debt outstanding – if only National Grid had cash to spare.
In the last year, National Grid reported unlevered free cash flow of £360m, for a free-cash-flow yield of 1.1%, but its levered free cash flow came in negative to the tune of almost a quarter of a billion pound.
The Market
The market expects a drop in earnings per share and subdued growth for sales, neither of which bodes well for its stock price, although a market-beating dividend yield, stable operating margins and investment plans in the US are elements to like. Whether they’ll support a rally like the one National Grid has enjoyed in the last five years (+50%, some four percentage points below the FTSE 100 Index), that depends on a) the quality of its resulting asset base and related growth; b) leverage ratios, which must go down; and c), of course, benign stock market trends.
