The operator of Britain’s electricity and gas transmission systems, National Grid (LSE: NG), has seen a 30% share-price plunge over the past eight months.
I think the stock is attractive because of defensive qualities in the underlying business. The gas and electricity transmission systems in the UK are the huge overhead cables and pylons, and the massive underground pipes, that carry electricity and gas long distances up, down and across the country, shifting the energy to where it’s needed. National Grid earns around 50% of its operating profits from Britain’s transmission systems and also operates a big electricity & gas business in the US as well as conducting a handful of other business activities.
Robust incoming cash flow
When the energy arrives at a local area, smaller, lower-voltage cables and lower-pressure pipes distribute the gas and electricity to towns and villages. National Grid doesn’t have much to do with the local distribution systems in Britain, but distributors have to buy gas and electricity that it has transmitted, which means the firm makes a little bit of money on most units of energy that are sold to the eventual end customers for gas and electrical energy.
National Grid operates a monopoly when it comes to energy transmission in the UK. It’s a bit like the owner of a toll bridge charging you a fee every time you cross the river. If that’s the only bridge and you want to cross the river, you will pay the fee. In a situation like that, the owner of the toll bridge knows that incoming cash flow will be pretty steady, because every day, people will need to cross the river on the bridge.
And that’s the big attraction with National Grid. The flow of incoming cash into the business is steady because people want to use gas and electricity every day. Reliable and predictable cash flow is the main reason for labelling some firms as ‘defensive’, and it follows that defensive businesses are good at paying consistent dividends to investors like us.
A theme in the stock market
However, I think there’s a theme running in the stock market right now where defensive stocks such as this have sold down over the past eight to 12 months or so. With National Grid, some are worried about political and regulatory risk affecting the firm’s business model. But I reckon the biggest factor in the share price slide could be that the defensives had become over-valued and we are seeing a rotation of investors out of them and into cheaper-looking cyclical alternative investments.
Yet the sell-off may be about to end. At some point, the dividend yield available will become so compelling that buyers of the stock will overwhelm sellers and halt the fall of the share price. When that happens, you’ll probably see the effect on the share-price chart and that point will be a good time to research the company with a view to buying some of the shares. Of course, National Grid’s privileged monopoly position in the energy market attracts fierce regulatory scrutiny, and the unknown effects after Brexit are muddying the investment waters, but those uncertainties could be creating an opportunity for investors.
