In a market wrestling with inflation, a consumer squeeze, spiralling deficits, and interest rate uncertainty, National Grid (LSE: NG.) shares offer something rare: earnings visibility. And with demand for electricity continuing to grow, I am becoming increasingly attracted by its investment proposition.
Monopoly
The company owns and manages the wires and substations that transport electricity all over the country. Its returns are linked to inflation and not volatile power markets.
To put it another way, it earns a predictable return for operating the network. This simple business model also becomes additive. A bigger network translates into higher returns.
Today, the business is in the midst of a huge infrastructure modernisation programme. Out to 2030, It has committed to investing £60bn.
The upshot of all this investment is that group assets are expected to grow at a compound annual growth rate (CAGR) of 10%. Underlying earnings per share CAGR will be in the 6%-8% range.
Regulatory reform
Two major reforms introduced this year will provide fresh momentum to the company’s investment plans.
In April, Ofgem published a report that should hopefully accelerate the connections process. Its “is it ready” and “is it needed” regime will clear the backlog of speculative projects and prioritise those that can actually deliver power to the system. This will unlock faster, more certain network connections.
Meanwhile, new planning legislation aims to shorten approval times for big energy projects. While these reforms will be most impactful in the 2030s, the legislation should help reduce risks associated with delivering large projects.
Projects already under construction include Eastern Green Link 1 and 2. Both are 2GW high-voltage direct current undersea links connecting Scotland with the north of England.
Delays and costs
Such a massive capital investment programme does not come without risks. It is promising to see that the regulatory environment is evolving, but that on its own will not be enough.
The main risks lie in execution and politics. Massive infrastructure delivery brings exposure to cost inflation, supply chain bottlenecks, and local planning opposition.
The latter is particularly worthy of further mention. Most residents in locations where new pylons are set to be installed, vehemently oppose them. As much of the infrastructure will be installed in rural countryside, the company will need to work in much closer cooperation with such stakeholders. A bulldozer mentality is unlikely to be successful.
Dividends and growth
Utility stocks are mostly viewed by investors as ‘steady but slow’. But this cycle I am becoming increasingly convinced that such characterisation will not turn out to be the case. I would liken it more to ‘defensive and growing’.
Dividend visibility is undoubtedly the main attraction. After it re-baselined returns lower last year, the current dividend yield sits at 4.1%. With earnings visibility, dividends per share are expected to grow yearly at the rate of inflation.
The UK has set an ambitious target of delivering 50GW of offshore wind by 2030. Such ambitious targets are needed as the electrification of heat and transport accelerates over the coming decade. Then there is an explosion in demand from AI data centres.
Visibility, resilience, and growth are the key watchwords to me. With such a compelling mix, I will buying shares in the company very soon.
