National Grid plc (LSE: NG) is one of the FTSE 100‘s top income stocks. As the owner of the UK’s power distribution network, the company holds an unrivalled monopoly over critical power infrastructure. And as well as it’s UK presence, it also manages power networks in the US northeast, specifically New York, Rhode Island and Massachusetts, giving diversification away from its home market.
The company’s monopoly over Britain’s power network means that it has a predictable, steady income stream giving management scope to pursue a predictable, progressive dividend policy. Over the past six years, the firm’s per-share dividend to investors has risen by around 1.3% per annum. This growth, coupled with its defensive nature and dividend yield (for the past five years the shares have supported an average yield of 4.8%) has made the shares a safe haven for income investors seeking bond-like income for the past decade.
However, since summer last year, shares in National Grid have taken a beating as the market has become increasingly concerned about the group’s outlook. Threats from the Labour Party coupled with a tough stance by regulators have led to concerns that the monopoly and income stream might not be as stable as investors believe.
Income under pressure
Shares in National Grid started to slide over the summer following news that, if elected into power, Labour will look to nationalise the company.
While this plan is unlikely to come to fruition any time soon, it has reignited the debate over whether or not consumers are getting value for money from energy companies. Energy regulator Ofgem is starting to take action. Earlier this week the regulator told National Grid that its cost estimate of £800m to connect the new Hinkley Point nuclear power station to the electricity grid was too high and suggested a structure that it said could save consumers more than £100m, which the company quickly criticised.
Under the current structure, energy firms indicate how much they need to spend over the following eight-year period, and Ofgem then decides what is fair. It has recently conceded that in the past, companies have been earning excessive returns, and from 2021, this will change. So, it looks as if the fight over the Hinkley Point project could be just the beginning for National Grid.
With returns set to fall, management will have to choose between cutting dividends to investors or cutting investment. With £5.2bn of operating cash flow reported for the fiscal year to 31 March 2017, against capital spending of £3.5bn and a total dividend payout of £1.5bn, there’s not much room for manoeuvre.
Is a cut coming?
As the new regulatory regime isn’t expected to come in until 2021, and as National Grid is not wholly dependent on the UK for its income, I don’t think a dividend cut will be announced any time soon.
That being said, it’s likely management will take a more cautious approach to cash distributions in the future as margins are squeezed.
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Rupert Hargreaves owns shares in National Grid. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.