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National Grid share price: is now the time to buy FTSE utilities?

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Like most FTSE 100 stocks, the National Grid (LSE: NG) share price plunged earlier this year. However, unlike shares in airlines and travel industries that experienced huge double-digit drops, National Grid remains relatively buoyant.

In fact, its coronavirus-related stock fall of 8% has been comparatively small. So far, the UK stock market appears to be unconcerned by the electricity distributor’s 2020 fiscal year reports of lower pre-tax profits and a forecast underlying earnings hit of £400m for 2021. We’ll see if this lasts.

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But for now, the firm’s share price is climbing again. 

National Grid share price

The share price has demonstrated positive growth over time looking as far back as 1995. However, increased competition, tougher regulation, and collapsing profitability in the thermal generation sector resulted in lower margins throughout 2016/17.

The stock price reacted accordingly, underperforming the wider FTSE 100 Index. But the coronavirus pandemic flipped this on its head. The power generation firm returned a positive 0.4% return over the last six months, compared with a negative 18.1% for the FTSE 100 as a whole.

National Grid owns power generation facilities in the US and the UK but its returns on these regulated assets have been dropping over time. Indeed, its reported figures show a 9.7% drop in earnings per share over the last five years.

However, regulators set utility tariffs in line with interest rates. And in the current environment of ultra-low rates, this is to be expected. I suspect this is already incorporated into the share price.

National Grid dividend – the downsides

National Grid offers a juicy dividend with a 5.1% yield. Moreover, despite the recent bad news of lower profits, the firm is sticking with its dividend for the next financial year.

However, in 2019, it paid more in dividends than it made in either profits or free cash flow. Consequently, its payouts weren’t covered by either earnings or cash. Lower profits this year, combined with a small dividend increase, makes me nervous for the future. A dividend cut may be likely at some point.

That said, the dividend has been stable over the last 10 years. I calculated a compound annual growth rate of around 2.1% which is very impressive. But, unless National Grid can start increasing its margins, this will be unsustainable.

As a natural monopoly, National Grid should be in a good position to do this. Moreover, CEO John Pettigrew expects any economic damage from the Covid-19 industrial shut-down to be “largely recoverable over future years“. The company will be hoping he’s right. 

Investing in FTSE utilities

Utilities have a reputation for being unexciting but dependable. They are usually high yield with a long history of dividends payments. This is certainly true for National Grid. Moreover, they’re traditionally defensive — in a pandemic, people still need water and power.

However, earlier this year, the utilities sector wasn’t its usual safe haven. The long period of low interest rates means investors have been searching for yield in stocks with high dividends, such as utilities. Before the pandemic, the sector saw record-high valuations, not yet reversed. 

But with the FTSE 350 Utilities Index providing a 12% return over the past year, it’s easy to see the attraction. Especially when its non-specialised peer, the FTSE 350, returned a negative 14.7%. 

Perhaps utilities are worth a further look. But despite high yields, I’m not yet convinced.

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Rachael FitzGerald-Finch has no position in any of the shares mentioned. 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.

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