It’s hard to overstate the benefits of a business enjoying a monopoly over something as essential to everyday life as electricity. Annual results released from National Grid (LSE: NG) today show just how beneficial that can be — a 6% rise in operating profits and full 10% jump in adjusted earnings per share. While the strong US dollar helped results, since 30% of operating profit comes from the States, the underlying UK business also posted solid but not spectacular results.
Poised for further growth
The utility is poised for further growth thanks to increased revenue from selling electricity to other countries and the possible sale of the UK gas distribution network it controls. Operating profits from electricity sales to France rose 19% last year, and similar connections are being built to Belgium and Norway. The group also confirmed in the annual report that it is still in the process of separating its gas distribution business in order to sell up to 75% of it.
The plan is to use the potential £11bn in proceeds from this disposal to invest in faster growth areas in the US and core electricity generation. National Grid is already pumping cash into US operations to the tune of $2.7bn in capital investments last year. With operations in only three states in the Northeast, there is definitely space to grow as older power plants are decommissioned and renewable energy is emphasized more.
Aside from these growth areas, the underlying electricity transmission business continues on a steady path due to regulatory oversight, although operating profits fell year-on-year due to one-off payment received in 2014. The stability of this business allowed dividends to rise 1.1% for the year to yield 4.4%. Looking ahead, this dividend should only grow, thanks to the regulated business’ stability, a large one off dividend from any sale of the gas distribution business, and growth in the US.
Unlike National Grid, SSE (LSE: SSE) has to worry about generating and transmitting energy directly to customers. Falling profits from each of these units led to earnings per share dropping 3.7% in 2015. Despite this drop in profits, the company still increased its dividend by 1.1% in order to achieve its target of increasing shareholder returns in line with or above inflation. Unfortunately, falling profits mean dividend growth slowed for the second year in a row and earnings only cover this payout 1.34 times.
A much more complicated business
The biggest hit SSE took was a 94% fall in operating profits generated by its gas production unit, as prices fell precipitously over the past 12 months. While this unit can be expected to bounce back eventually, there are worries about other divisions at the utility.
Retail customers continue to leave SSE in droves as price wars abound between the established ‘Big Six’ energy suppliers and smaller upstarts, particularly in the renewable field. Increased numbers of corporate customers more than made up for this last year, but if households continue to leave in droves this will be worrying in the long term as they make up the vast majority of its customers.
Overall, SSE’s exposure to commodity prices and having to fight to attract and retain household and business customers make it a much more complicated business than I want from my utility investments. And, although SSE’s dividend is higher, National Grid’s appears safer to me and its share prices have vastly outperformed its smaller rival’s over the past decade.
