For many investors, a key attraction of National Grid (LSE: NG) is the passive income potential it offers. National Grid explicitly aims to grow its dividend in line with a key measure of inflation.
That reassures many investors, as they equate it with a dividend that holds its value over the years in real terms. What might that mean in the coming decade?
Growing with inflation
There are a couple of things that are helpful to understand. One is that there is more than one common measure of consumer inflation.
National Grid aims to grow its dividend per share in line with what is known as CPIH. That is a mainstream inflation indicator: the Consumer Prices Index including owner occupiers’ housing costs.
In the 12 months to October, CPIH grew 3.8%. But inflation can move up or down over time – it can even become negative, when it is called deflation (though National Grid aims to grow its dividend each year, not only to match CPIH)
In recent years, CPIH has sometimes got close to double digits in percentage terms. For the 12 months to October 2022, for example, it was 9.2%.
But it has spent much of the past decade at under 3%.
Could the dividend double?
Say inflation was to stay at its current level of 3.8% a year. Over the coming decade that would mean total inflation of 45%.
If the National Grid dividend grew in line with that, then it would not double in the coming decade. It would take 19 years for the dividend to double if it grows by 3.8% a year.
However, if CPIH was stubbornly higher (say, 7.5%), then over a decade it would mean total inflation of over 100%. Matching that would mean the National Grid dividend doubling within 10 years.
I see that as unlikely, but not impossible. A sustained inflation rate that high strikes me as unlikely – but predicting inflation can never be done with certainty. In fact, even measuring past inflation accurately is so difficult that figures are sometimes corrected after they are initially released.
Not the share for me
Looked at like that, it might sound as if higher inflation would be good news for National Grid shareholders.
But that may not be the case. The inflation peg is supposed to mean that the dividend basically stays flat in terms of actual spending power.
On top of that, inflation means higher costs for the company. From buying equipment to paying wages, inflation adds costs that could eat into profits.
In fact, the high cost of maintaining and improving the company’s power distribution network is what puts me off buying National Grid shares, despite the current 4.2% dividend yield.
While the company’s interim dividend for the first half of this year grew 3% year-on-year, its capital investment grew much faster, at 10%.
National Grid expects to spend over £11bn on this in 2025-26 alone, pushing net debt up by around £1.5bn to well over £40bn.
The company’s network and effective monopoly are massive competitive advantages. But they require high capital expenditure, which is why net debt has risen.
That also helps explain last year’s 20% cut in the dividend per share. From a dividend perspective, there are shares I prefer own rather than National Grid.
