One concern a lot of investors have is about the impact of inflation on their passive income streams. Even when a company grows its dividend per share each year, if that growth is not as strong as inflation, its value in real terms could fall over time. That helps explain why National Grid (LSE: NG) attracts some loyal private investors. The FTSE 100 power network operator aims to grow its dividend per share annually in line with a leading measure of inflation – or even more.
Could that make it the sort of passive income generator I would like to have in my portfolio as a way to try and mitigate the potentially harmful impact of inflation on my dividend income?
This business has some compelling characteristics
Before getting into the dividend, let me explain why I like the National Grid business.
People need power and, over time, consumption looks set to grow, not decline. Moving power from where it is generated to the point of use will therefore continue to be big business.
Not only is it big business, but it is also one that is costly and difficult to get into. The sort of networks that National Grid has built over decades are impossible to replicate in many cases. Even if a rival could do so, it would likely be prohibitively expensive.
That gives National Grid strong pricing power – potentially so much, in fact, that the government regulates many of its prices. That can be seen as bad for profit potential, but it does help provide some transparency about possible future pricing levels.
But there’s something I don’t like about National Grid
So far, so good.
However, while the company has a lot of strengths, its chosen area of business also exposes it to a significant challenge. That is keeping the network operational and fit for purpose.
That is not just about sending a couple of engineers out in vans on a stormy night (important though that can be). It also involves the enormous task of maintaining and reshaping the grid to meet changing patterns of energy generation and consumption.
Such infrastructural work is expensive.
How expensive? Put it this way: in the first half of its current financial year alone, the company spent £5bn on capital investment.
That is a lot of money even for a business with a market capitalization of £63bn. Indeed, ongoing capital expenditure helps to explain why National Grid has amassed a net debt of £42bn.
The dividend has been cut before – and could be again
So what, you may ask.
National Grid’s high ongoing revenue generation potential could surely help fund such capex requirements?
In reality, the funding is an issue. Revenue in the first half was £7bn. So that £5bn of capex is substantial.
It makes sense that a power network operator spends a lot of money on maintaining and updating the network. However, National Grid has other things it needs to fund too, from paying interest on that large debt pile to employee wages.
A dividend cut could be one solution to its spending needs and indeed, it already reduced the dividend per share last year despite its stated aim of growth.
I fear that could happen again in future, so I have no plans to invest.
