It’s been a rough two-year period for National Grid (LSE: NG) shareholders. Two years ago, the stock had just enjoyed an excellent seven-year run in which its share price had more than doubled and was trading above 1,100p. However, since then, the stock has declined significantly, and it currently trades for less than 800p. So what’s going on?
Uncertainty
I can list a number of reasons why sentiment towards National Grid is poor right now.
For starters, there’s the political situation. With the chaotic handling of Brexit, it appears that many people are losing faith in the Conservative party and that Labour has a real chance of being voted in at the next election. Given that Labour leader Jeremy Corbyn has plans to take parts of Britain’s energy industry back into public ownership if he gets into power, this naturally adds uncertainty to the investment case for National Grid.
Then there’s the recent profit warning from SSE which won’t have helped sentiment either. The energy provider warned that its half-year profit would halve, hurt by warm weather and persistently high gas prices, which caused a sell-off across the whole sector.
Third, we have rising interest rates, which are generally not good for utilities companies as these companies tend to have high levels of debt, which means higher interest costs. National Grid’s high level of debt (its long-term debt-to-equity ratio is 120%) is probably also a turn-off for many investors.
Lastly, after such a strong run between 2009 and 2016, a pull-back was always likely. Two years ago, the stock was trading on a forward P/E ratio of around 18, which in hindsight, was probably too high for a low-growth utilities firm. Today, the forward P/E is 14.
Do the shares offer value now?
After a near-30% share price fall, do National Grid shares offer value at the moment?
There are elements of the investment case that do look attractive, in my view. The group sold its mature UK gas distribution business back in 2017, and is now focusing on other growth areas such as US assets. It’s worth noting that the company now generates over half its revenues from the US and that this part of the business is outside UK regulation. Earlier this year, National Grid advised that it is expecting growth of 5% to 7% per year and stated: “The business is well positioned with a balanced portfolio and an efficient balance sheet that underpins asset and dividend growth.”
Then, there’s the big dividend yield on offer. With the group expected to pay out a dividend of 47.3p per share this year, the prospective yield stands at a high 5.9%, which is one of the higher yields in the FTSE 100 index. That yield certainly looks appealing in today’s low-interest-rate environment, and the group’s policy is to increase its payout in line with RPI inflation, which is handy with inflation rising.
Risks
However, there are risks to the investment case, as there are with any stock. Looking at the uncertainty surrounding NG, I probably wouldn’t call the current P/E ratio of 14 a ‘bargain’ just yet, but a little bit of value is beginning to emerge.
