One dividend growth stock I’d buy alongside National Grid plc

Roland Head believes that the National Grid plc (LON:NG) sell-off may have gone too far.

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Sometimes stock market bargains can be found in unlikely places. I reckon one potential example of this is utility firm National Grid (LSE: NG), whose shares have fallen by almost 25% since May last year.

Some headwinds

In fairness, one reason for this decline is that earnings forecasts for the group have been revised downwards as energy market conditions have changed.

Looking further ahead, there are also concerns about how well the UK’s power grid will cope with future demand from renewables, electric car charging and the potential need for energy storage. National Grid may need to invest heavily to modernise its infrastructure.

A final risk is that a future government might take a more populist line towards the privatised utilities, using price caps and other measures to restrict their profits. However, I suspect these risks will materialise more slowly and gradually than National Grid’s sliding share price suggests.

A contrarian buy?

Adjusted earnings are expected to rise by around 3% to 58.6p per share this year, covering the forecast dividend of 46.2p per share 1.3 times. These projected figures give the stock a forecast P/E of 14.4 and a prospective yield of 5.5%, which seems attractive to me.

That’s especially the case given National Grid’s policy of increasing its dividend in line with inflation. While this results in fairly small increases each year, it does work well for investors wanting a stable income.

And while a dividend cut isn’t impossible, the group’s earnings are expected to improve by 5% in 2018/19. This should widen the level of dividend cover slightly and reduce the chances of a cut.

What about growth?

If you’re looking for a dividend stock with genuine growth potential, one company I’d consider instead is Chemring Group (LSE: CHG). This defence group is still in turnaround mode after a troubled few years.

But today’s full-year results suggest to me that the company’s problems are under control. I believe Chemring could now be positioned to deliver steady growth over the next few years.

During the year to 31 October, the group’s revenue rose by 15% to £547m, while underlying operating profit rose by 14% to £55.4m. Net debt fell by 9% to £80m, while the dividend climbed 131% from 1.3p to 3p per share.

These figures indicate an underlying operating profit margin of 10.1%, which is fairly attractive. Although the group’s free cash flow generation was dented by a number of one-off costs related to its restructuring, I expect these to reduce this year, freeing up more cash for debt reduction and dividend growth.

A potential catalyst

Chemring is the second defence company I’ve looked at this month which has commented that US defence spending seems likely to rise. The US is a key market for it and stronger sales here could help to accelerate growth.

I believe that now could be the right time to buy Chemring as a long-term hold. The shares trade on an undemanding forecast P/E of 14 for the year ahead, and look cheap to me in historic terms. Although the forecast dividend yield is modest at 1.7%, I’d expect this to increase steadily over the next couple of years. Buying now could lock in an attractive future income.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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