Some investors like utilities because they reckon they have defensive qualities. For example, customers need the services of power network operator National Grid (LSE: NG) even when the economy is doing poorly. So, could National Grid shares be a good long-term pick for my portfolio?
Large business in a shifting landscape
When thinking about the booming demand for AI, do you ever think about where the power for the data centres will be generated – and then moved around?
Most of us probably do not think about that much, if at all. For a company like National Grid, though, shifting patterns of power generation and consumption are a significant consideration.
It is true that utilities and monopolies can have attractive economic characteristics. National Grid has a large customer base many of whom have few if any alternative service providers for the job in hand. Demand is likely to stay high for the foreseeable future.
Set against that, though, are the costs involved in maintaining a complex existing infrastructure, even before the money needed to reshape it as power demands change.
National Grid has been spending vast amounts of money in recent years to do this. Its balance sheet now carries £42bn of net debt.
Share price has moved upwards
Still, over the past five years, National Grid shares have moved up 47%.
One hundred shares bought five years ago, at a cost of around £805, would now be worth some £1,187.
The growth means that National Grid shares now sell for around 20 times earnings.
Dividend growth potential
While National Grid shares have moved up in price over the past five years, that is not the only thing that has helped build wealth for shareholders.
The company also pays a dividend that it aims to grow at least in line with a leading measure of inflation.
Currently the yield is 4%. But someone who bought five years ago will be yielding more thanks to a lower purchase price back then. One hundred National Grid shares would have earned close to £47 in dividends last year.
The interim dividend this year has grown and I expect the final dividend will too, in line with the company’s stated dividend policy.
However, dividends are never guaranteed – and this popular income share demonstrates that.
Last year, National Grid sharply reduced the dividend per share. In the context of its capital expenditure requirements and debt that is understandable – but as a potential investor it damaged my confidence in the company’s ability to keep growing its dividend regularly in future.
I won’t be buying
As well as last year’s dividend cut, National Grid diluted existing shareholders in 2024 to raise more cash. I see a risk that could happen again.
This is a business that has the potential to generate sizeable cash flows, but it is also eating up a lot of cash at the same time. I think that dynamic could continue in coming years.
Between the valuation, debt load, and long-term uncertainty about hitting the stated target of annual dividend growth, I am steering clear of National Grid shares.
