After that pullback, National Grid shares now sport a dividend yield of 5.6%. That’s certainly attractive in the current low-interest-rate environment. Should I buy the stock now to pick up that high yield? Let’s take a look at the investment case.
National Grid shares: a reliable dividend investment
In the current environment, in which economic uncertainty is elevated, I can definitely see some appeal in owning a stock like National Grid.
Utilities is a very defensive sector. No matter what the economy is doing, we still need essential services such as electricity and gas. Utility companies also often operate under the protection of government regulations, which adds further resilience. What this means is that utility companies are generally able to generate relatively steady profits and cash flows throughout the economic cycle. This translates to reliable dividends.
This year, National Grid certainly hasn’t disappointed on the dividend front. While many other FTSE 100 companies, including the likes of Royal Dutch Shell, BT Group, and Lloyds Bank, have suspended, cancelled, or trimmed their dividends, National Grid has lifted its payout. Recently, in its full-year results, the group announced a 2.6% increase in its dividend, to 48.57p per share, in line with its policy to increase the payout at least as much as RPI inflation. That’s an impressive achievement, given the economic environment.
National Grid: dividend analysis
Taking a closer look at National Grid’s dividend, however, I do have some concerns. For a start, dividend coverage isn’t high. Last year, National Grid generated underlying earnings per share of 58.2p. This means the dividend coverage ratio (earnings per share divided by dividends per share) was just 1.2. That’s quite low. Ideally, I like to see a dividend coverage ratio of at least 1.7. The higher the ratio, the less chance of a dividend cut in the future.
Secondly, National Grid has a large amount of debt on its balance sheet. In its full-year results, the company said it had net debt of £28.6bn and was expecting this to increase by around £3bn this year. By contrast, total shareholders’ equity was £19.6bn. This amount of debt adds risk to the investment case.
Finally, I’ve some concerns about the level of growth here. Over the last three years, revenues have fallen by around 3%. That’s not ideal. Revenue growth drives dividend growth. On top of this, British energy regulator Ofgem has said it wants UK energy network operators to invest £25bn from 2021 to 2026 to deliver emission-free energy. This could hit National’s Grid’s profits.
NG shares: my view
Weighing everything up, I’m going to pass on National Grid shares for now. The dividend yield of 5.6% is, no doubt, attractive. However, all things considered, I think there are better dividend stocks to buy at the moment.
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Edward Sheldon owns shares in Royal Dutch Shell and Lloyds Bank. The Motley Fool UK has recommended Lloyds Banking Group. 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.