I haven’t looked at National Grid (LSE: NG) since mid-June and since then it has embarked on a decent run, its stock up 8% . I am pleased because at the time I said it looked like an unmissable bargain. So what does it look like now?
The £26.5bn FTSE 100 company is still in bargain territory judging by its P/E ratio, trading at a forward valuation of 13.9 times earnings. However, its share price trades 27% lower than two years ago, and those who think of utility stocks as defensive plays really need to think carefully about what that term actually means.
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Unlike many domestic utilities, National Grid boasts a thriving US business, which offers some relief from domestic concerns such as Brexit, customer anger over rising energy bills and renationalisation threats from a resurgent Labour party.
Jeremy Corbyn’s threats to take utilities back into public ownership are weighing on National Grid , even though its CEO has claimed it would cost a whopping £100bn. As yet, shareholders have no idea what compensation they would get if that happened. As the Conservatives flounder and Labour confidence seeminglygrows, these concerns may continue to weigh.
In the current fraught environment, Government and regulators feel the need to bare their teeth with Ofgem seeking £5bn of savings through tougher price controls for energy networks. This has already hit National Grid’s bottom line, as the regulator is using a tougher benchmarking approach on its grid upgrade to connect the new Hinkley Point C nuclear power station.
The recent profit warning from Big Six power giant SSE has further dented sector confidence, while National Grid’s hefty debt-to-equity ratio of 120% could weigh on it if interest rates continue to rise.
In return for all these worries investors also get an electric yield of 5.7%, with cover of 1.3. The dividend is forecast to hit 6.1% in early 2020, and today’s cut-price entry point still looks tempting.
United we fall
United Utilities Group (LSE: UU) has had an even stickier time, the share price dropping 30% in the last two years. With a forecast yield of 5.8%, covered 1.3 times, and a valuation of 13.7 times earnings, its profile looks remarkably like National Grid’s.
Once again, the £4.72bn group has also been hit by the threat of Corbyn as Prime Minister and a potential Chancellor John McDonnell, who last month mooted spending £80bn bringing the water companies back into public ownership run by local councils, workers and customers.
United Utilities is also facing a cost squeeze, recently stating that it is planning for a 10.5% reduction in average bills between 2020 and 2025. It also had to invest £80m to help it to safeguard water supplies and protect resources during the dry summer.
Encouragingly, the most recent UK Customer Service Index placed it top among all water and wastewater companies, while City analysts are forecasting healthy 15% earnings per share growth in the year to 31 March 2019, then another 10% the year after. By then, the yield should hit 6%. So we have two great income stocks, yet both carry a worrying measure of political uncertainty.