Power Up Your Dividends With This Utility Stock

Income Investing

Investors tend to take one particular U.K.-based electric utility for granted. Its history of predictable and defensive returns has long made it a no-brainer for income investors. Its dividend, which grows in line with inflation, has not been cut since 1996.

Let’s take a look to see if it’s worth your time…

The company I’m speaking about is National Grid (NGG), which the British government privatized in 1990. It owns, develops, and maintains the infrastructure that transmits electricity around England and Wales.

It also does the same, as well as distributing natural gas, here in the U.S.—in New York and Massachusetts—accounting for 45% of its profits.

National Grid

In the U.K., the company is essentially a monopoly and is therefore highly regulated. It is only allowed to make a certain rate of return, determined in advance by the regulator Ofgem (Office of Gas and Electricity Markets) and put in place for several years at a time.

Ofgem made its latest determinations for electricity distribution, covering 2023 to 2028, at the end of 2022. In its investor presentation, the company announced its new electricity distribution price control, targeting 100 to 125 basis points in operational outperformance as compared to the previous price control measure.

Ofgem’s price control framework is complex. However, in very simple terms, here is how it works: the bigger National Grid’s asset base becomes, the more money it is permitted to make—particularly given that its U.K. asset base is indexed to inflation.

The abundance of U.K. and the U.S. investment opportunities in aging energy transmission networks and renewable energy should be a boost for the business. For example, National Grid was awarded a $50 million grant from the U.S. Department of Energy (DOE) for a project that will deploy digital technology to optimize the use of distributed energy resources (DERs) to improve electric system reliability and resilience. In addition, an ever-growing network of renewable energy in Britain and the U.S. will push the company’s earnings and dividends higher.

Some worry that National Grid has low equity and lots of debt; however, it has been this way for many, many years. Dividend cover has been slim, even in the best of times, with earnings-per-share only slightly higher than dividends-per-share. But the company has almost always surprised investors in a good way—and analysts at Credit Suisse actually expect dividend cover to improve slightly over the next few years.

Back in 2021, the company decided to shift its focus completely to electricity and move away from gas. The goal was to transform National Grid from a low-growth gas transmission business to a higher growth utility business. It agreed to buy Western Power Distribution (WPD)—which ran grids in the English midlands and southwest regions, as well as in Wales—from U.S.-based PPL Corporation (PPL) for about $11 billion.

The company’s decision to sell off its gas assets should also free up some cash. In July, National Grid sold a further 20% stake in its U.K. gas transmission and metering business to the existing majority owners, an investor-consortium led by Australia’s Macquarie Asset Management. The stake sale was on the equivalent financial terms as when it sold a 60% stake to the consortium in January. That deal had implied an enterprise value of about $12.5 billion for the unit, National Gas.

Over the longer term, these monies—when plowed into infrastructure—should yield ample rewards for shareholders.

Investing in National Grid

If you’re interested in NGG’s dividend policy, it’s different from that of U.S. utilities.

The company’s dividend payout is linked with the rate of CPIH inflation in the U.K. CPIH is the Consumer Prices Index, including owner occupiers’ housing costs. CPIH inflation is currently at 6.3%, compared with a peak of 9.6% last October.

I believe that electricity infrastructure will play an increasingly important role in the move towards net-zero emissions. National Grid is well positioned to capitalize on this industry trend, given its demonstrated leadership on climate change. Its move to increase the weight of electricity networks over gas ones against a backdrop of accelerating energy transition has been sensible.

I consider the company a dividend aristocrat: it has been increasing its dividend every year since 1998, delivering an impressive 6.3% average annual growth over that time period. In the period from 2005 to 2012, the dividend grew at a 10% annual rate. And, thanks to the high selling price of its U.K. gas transmission assets, National Grid should be able to continue to grow dividends in line with inflation.

Keep in mind that inflation is a good thing for NGG, and its income-seeking investors. The stock (current yield 5.61%) is a buy in the $58 to $62 range.