National Grid for income

National Grid's UK regulated businesses have a good track record of outperforming Ofgem's expectations for return on equity. During the 2015 financial year, the group's core electricity transmission business delivered a 14 per cent return on equity, compared with 12.4 per cent in 2014. More impressively, Ofgem had assumed the business would generate a 10.2 per cent return on equity during each of these years. By coming up with more innovative engineering methods, such as using helicopters to survey overhead power lines for maintenance purposes, the group managed to deliver efficiencies for a lower cost than Ofgem envisioned. Total expenditure for electricity transmission was £1.3bn, compared with an estimated allowance of £1.5bn.

Management expects the business to outperform its allowances again this year. Under the balancing services incentive scheme (BSIS), which rewards National Grid for minimising the cost of operating the national electricity transmission system, the business gained £23m in pre-tax profit. What's more, the maximum profit available under the scheme has increased to £30m, meaning there is even more to play for this year.

The main attraction of National Grid's shares for investors is the generous dividend coupled with the policy of increasing the payment at least in line with retail price index (RPI) inflation for the foreseeable future. To make good on these dividend promises the group needs to keep growing its asset base to generate the necessary cash. In order to make sure the group is able to continue to grow its asset base at a target level of 5 to 7 per cent a year, management has announced its intention to sell the group's majority stake in the UK gas distribution business. Management reckons by selling this more mature lower-growth business, the group will be able to deliver asset base growth at the top end of the range. What's more, the bulk of the net proceeds of the sale will be delivered straight back to shareholders. The sale process is expected to complete in early 2017.

A focus for future growth will be National Grid's expansion in the US. During the last financial year, National Grid's US regulated business - essentially a conventional utility - was hit by an almost doubling of bad debts as customers struggled to pay their winter bills. However, this year the US business is ramping up investment in gas main replacement work. At the time of the first-half results, finance director Andrew Bonfield told us around 1m of its US customers were still without access to natural gas. As a result of this increased level of work, plus customer growth, US regulated investment increased by £222m during the first half of the year.

The step up in investment in the US network is expected to increase its base rate growth to 7 per cent this year. This should drive more revenue for the business, but in the short term return on equity (RoE) will be hampered by a time-lag in this increased investment being recognised in its regulatory allowances. This means management expects an operational return on equity of around 8 per cent, slightly lower than the 8.4 per cent achieved the previous year.