National Grid Plc’s 2 Greatest Strengths

ngWhen I think of gas and electricity transmission system operator National Grid (LSE: NG) (NYSE: NGG.US), two factors jump out at me as the firm’s greatest strengths and top the list of what makes the company  attractive as an investment proposition.

1. Operational monopoly

In the UK, National Grid owns the nation’s gas and electricity transmission systems, which transport gas and electricity long distance at high pressure and high voltage respectively. It’s a bit like a toll bridge: if you want to use the system to transport your energy, you must pay a fee, and that’s exactly what energy suppliers do. There’s next-to-zero chance of a competitor setting up to offer an alternative transmission network, so in that sense the firm enjoys a monopoly position in Britain’s energy market.

As well as operating Britain’s transmission systems, National Grid runs four of the country’s eight regional gas distribution networks and also has interests in the north eastern US, where its business includes electricity generation, transmission and distribution assets, and gas distribution networks. In an unregulated market, the firm would hold a licence to print money, but its operations face fierce scrutiny on both sides of the Atlantic.

Regulators set maximum earnings limits and minimum investment thresholds, which ensure the firm keeps investing in its assets to raise efficiency, whilst maintaining fair pricing for the end consumer. By balancing capital expenditure, regulatory compliance and interest payments on debt, National Grid manages to deliver a steady cash flow, which it uses to reward shareholders by growing the dividend at least in line with its stated goal of mirroring the rate of retail-price inflation.

The recent full-year results reveal steady progress:

Year to March 2010 2011 2012 2013 2014
Net cash from operations (£m) 4,516 4,858 4,228 3,750 4,019
Adjusted earnings per share 55.05p 50.9p 50p 57.8p 66.4p
Dividend per share 38.49p 36.37p 39.28p 40.85p 42.03p

2. Predictable demand

The rolling seasons produce a steady and predictable cycle of demand for energy. Some winters are colder than others, which lead to variable winter heating loads, but over a period of several years, National Grid can make a good job of predicting its earnings. Macro-economic cycles have some effect too, but generally, the population tends to keep the lights and heating on no matter how tough times are.

That means the firm can budget for its future capital requirements with a reasonable degree of accuracy, which lends a measure of security to the dividend payment, as earnings shocks are unlikely to force a hasty dividend cut.

As well as a potentially safe dividend, National Grid has what it calls an attractive pipeline of value-adding investment opportunities for long-term growth in the UK. Meanwhile, across the pond, the firm’s customers are continuing to look for ways to reduce their fuel bills, such as by switching to natural gas as a heating fuel, which offers further growth potential, say the directors.

What now?

At a share price of 876p, National Grid’s forward P/E rating is running at just over 15 for 2016. The dividend yield that year should be about 5.1%, but city analysts following the firm expect earnings to slide 18% in 2015 before recovering by 6% the year after.

Many investors will be attracted to National Grid for the apparent security of the dividend payment but, given the immediate growth outlook, the shares are starting to look pricey. That's why I'm also keen on three companies that seem set to do well this year. In fact, the Motley Fools top team of share analysts reckons these three could be among the best picks for the next decade.

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Kevin does not own any National Grid shares.