What's new
■ Solid performance in first year of UK price controls
■ Uncertainty surrounding investment in UK generation
■ Credit Suisse downgrades its recommendation
National Grid (NG.) has long been a core income holding but in recent times it has also served up decent capital gains. The shares have put on almost 50 per cent since the start of 2011 and investors who tucked this one away for its fat dividend yield must be delighted.
That strong performance has come from investors' appreciation of a model for generating returns that exceeds the cost of capital on its huge asset base of pylons, power lines and gas networks. Last year was the first year of the group's new seven-year price control for its UK transmission and distribution networks. National Grid did what it does best: it beat regulator Ofgem's assumed return on equity by 260 basis points by finding more efficiencies than Ofgem had expected.
But the other part of the Grid's success story - an expanding asset base - is looking a little cloudier. While most observers agree that investment in generation assets is needed to 'keep the lights on', political discord on how the UK's energy market should operate is causing uncertainty. That dampens enthusiasm for investment in new generating capacity, which some fear may in turn lead to slower asset base growth for the company.
Credit Suisse says...
Neutral. National Grid has consistently been one of the best performers across the utility sector and the market over the last valuation cycle. Since the lows of March 2009, the stock has delivered around a 143 per cent total return. But for the first time in three and a half years, we struggle to see anything more that National Grid can price in, or any significant valuation gap to be closed. The premium to regulatory equity value is around 74 per cent, just 12-19 per cent below the previous valuation peak. Only in 2007 and the first half of 2008 were National Grid's shares more expensive and we downgrade to neutral from outperform. Expect EPS of 55.3p this year (from 54p in 2013-14).
Morgan Stanley says...
Overweight. The UK outperformance is greater than we had expected in year one of the price control regime and is at the upper end of the chief executive's commitment made last summer. Our interpretation is that, with more operational improvements to come - even offset by some prior period benefits falling away - this outperformance should increase. In the UK we assume that National Grid will deliver a return on equity of 12 per cent to 2021 and that the regulatory asset value (RAV) will grow at 7 per cent between 2013 and 2021. This justifies the 22 per cent premium to RAV.
