The FTSE 100 has enjoyed an impressive double-digit rally since the start of 2024. But not all of its constituents have been so fortunate. And National Grid (LSE:NG.) shares in particular are now trading at levels close to their 52-week low.
Since 2023 ended, the UK’s largest electrical infrastructure enterprise has seen its valuation drop by around 8%. By comparison, its parent index is up around 7.5%, not including dividends. That means National Grid shareholders are losing to the market by 15.5%.
What’s going on?
Inspecting the problem
The business kicked off 2024 fairly well, with shares climbing at a similar pace to the FTSE 100. It wasn’t until last month that things took a turn for the worse.
Management has announced a pretty radical restructuring of the business to try and get debt under control as well as spark growth that hasn’t been seen in a long time.
The plan is to invest a whopping £60bn between now and 2029 in an attempt to deliver 10% annualised asset growth long term. The money’s will decarbonise the company’s energy infrastructure, improve supply, and ultimately lower bills for consumers through more efficiency.
The goal is undoubtedly admirable. But the cost has understandably spooked many investors. Even more so, considering the firm doesn’t exactly have a stellar track record when it comes to large-scale investments.
The plan also includes a £7bn equity raise. This will increase the number of shares outstanding by roughly a third, creating significant dilution for current shareholders.
The rest of the money is likely coming from debt financing and the disposal of some operations. In fact, management’s already announced plans to sell its UK liquified natural gas business, Grain LNG, as well as its onshore renewables enterprise in the US.
Considering this level of investment is double that of the last five years, investors are understandably concerned about the uncertainty it brings. After all, should these investments fail to deliver expected results, the company’s balance sheet could fall under enormous pressure.
A buying opportunity?
With the shares sliding on this announcement, the FTSE 100 stock now trades at a forward price-to-earnings (P/E) ratio of 12.5. Compared to its historical average of 16, that suggests it may be undervalued right now. So is this a chance to buy at a discount?
From a business perspective, investing in National Grid makes a lot of sense. Demand for electricity is rising and the firm should have very little trouble generating chunky cash flows. However, building, maintaining and upgrading electrical infrastructure isn’t cheap.
The effects of this massive capex are already reflected in the balance sheet with over £47bn of debt and equivalents on its books. And that’s before management announced its £60bn new investment plan. As such, the interest bill for its 2024 fiscal year, which ended in March, was £1.3bn, wiping out a massive chunk of operating profits.
In the long term, if the newly proposed investments are successful, the subsequent growth in cash flow would likely provide ample financial flexibility to start reducing leverage. But, personally, with so much of the firm’s future dependent on a single strategic decision, the risk seems too high for my tastes. Therefore, I’m keeping this business on my watchlist until I see how management’s new strategy is performing over the next few years.
