1 Reason I Wouldn’t Buy National Grid plc Today

Today I am looking at why the need for heavy investment could undermine National Grid’s (LSE: NG) (NYSE: NGG.US) dividend prospects.

Investment drive could dent dividend growth

It comes as no surprise that the complex nature of utilities operations means that National Grid is required to shell out vast sums in order to keep its operations up and running. Indeed, the business confirmed in last month’s interims that it expects invest £3.4bn this year alone in building and bolstering its infrastructure in the UK.

Meanwhile, the power giant affirmed its desire to fork out around $2bn (or £1.2bn) per annum in the US, which it intends to dedicate the lion’s share to “network reliability, including infrastructure replacement and modernisation“.

The power play has spelled out plans to keep growing its regulated asset base at a rate of 5% per year, but National Grid could see the amountnationalgrid1 required to keep the lights on rocket higher in coming years due to the current state of much of the infrastructure on both sides of the Pond. Indeed, chief executive Steve Holliday told a conference of academics and business leaders in New York last week that the entire energy community faces a multitude of challenges in the years ahead.

Not only must companies invest in replacing and updating a network of ageing generators, he said, but changes must also be made to existing technology in light of the growing need for renewable sources. On top of this, National Grid and its peers must also spend vast sums to insulate power grids against the effects of the growing problem of extreme weather conditions, Holliday warned.

Against this backdrop, doubts have arisen that National Grid’s reputation as a go-to dividend play may become tarnished as capital outflows rise and earnings come under pressure. Indeed, payouts of 43.3p and 44.6p per share for fiscal 2015 and 2016 respectively are covered just 1.3 times by prospective earnings, well below the safety watermark of 2 times.

Although heavy infrastructure investment is critical for long-term earnings expansion, income investors could be left sorely disappointed should annual dividend growth at National Grid subsequently come under pressure.

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Royston Wild has no position in any shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.