Here is why I’d buy National Grid (LSE: NG), hold Petrofac (LSE: PFC) and sell Admiral (LSE: ADM) right now.
National Grid Is Undervalued
NG’s revenues are likely to rise slightly above inflation into 2018, but a 25% operating margin will likely yield an underlying operating performance of between £4bn and £4.2bn over the period, which means that net leverage at about 4.4x should not pose any problems. Rising cash flows will likely continue to support a rich dividend policy — so, in my view, its forward dividend yield (north of 5%) is safe.
For all this, at 857p a share you are paying only 14x for NG’s forward net earnings, which is not much in a sector that is highly regulated and where cash flows are highly predictable.
NG’s stock price is down 5% this year and is flat over the last 12 months, but it could be argued that NG’s prospects and earnings profile could be boosted by more difficult trading conditions at some of its smaller domestic rivals, which are financially weaker, over the next couple of years.
Petrofac Promises More Upside
Petrofac’s stock price has been volatile in recent times — unavoidable due to recent oil price swings — but I think investors may have overreacted.
Its latest set of numbers showed that the oil services group is adapting well to the new environment, and while it’s true that with Petrofac you’d add more volatility to your portfolio than with National Grid, its earnings growth projections are much more appealing, yielding a forward net earning multiple of 17x that drops to around 8x in 2016 and 2017.
Its forward dividend yield at 4.7% signals more risk than that of National Grid, but Petrofac’s margins will likely expand over the next couple of years even if Brent oil doesn’t surge to its previous highs. Finally, consider that if bullish analysts are right, upside could be between 20% and 70% from its current level, while downside could be limited (in the region of 3%), at least according to market consensus estimates from Thomson Reuters.
Admiral & Regulatory Risk
“Car and home insurance premiums are set to increase due to an upcoming increase in the UK’s insurance premium tax, the AA said on Tuesday,” Alliance News reported today.
Elsewhere, the BBC also noted that, based on the AA’s survey, car insurance premiums “have risen for the first time for nearly three years, with young drivers facing the biggest increases” at about 6% in the three months to the end of June.
As a result, Admiral stock was up 5% at the time of writing. Today’s news is precisely the reason why I would not invest in Admiral and in similar insurers — in short, regulatory risk is incredibly hard to model.
Furthermore, based on cash flows and earnings, Admiral’s trading multiples are broadly in line with those of National Grid, but its operating cash flow/dividend ratio is much lower, which signals plenty of risk for a dividend yield that is projected at 6% over the next 30 months.
