National Grid's dividend cover another net-zero issue

John Pettigrew, chief executive of National Grid (NG.), prefaced the group’s half-year figures by announcing that its “financial performance reflects our role at the heart of the energy transition and a new phase of capital delivery that is firmly underway”. Unfortunately, that equated to a 21 per cent fall in underlying pre-tax profits, with all divisions falling short of the previous half-year, albeit largely due to non-recurring items.

The nature of the beast means that it’s not competing for market share in the everyday sense. National Grid’s rate-of-return is regulated to a large degree; the latest determinations for electricity distribution, covering 2023 to 2028, were made at the end of last year. It carries net debt equivalent to 1.5 times net assets. But it throws off mountains of cash at the operating level, enabling it to boost distributions while servicing that debt, and it is not directly exposed to price volatility in the energy market.

The trouble is that the group is now faced by unprecedented capital demands as the UK scrambles to put in place adequate power infrastructure – pylons and transmission cables – to facilitate the transition to the net-zero economy. The process has been aided by the recent passing of the Energy Act 2023 into legislation, but there are mounting uncertainties as to the level of “sunk costs” going forward and their potential impact on dividend cover. For investors, it’s worth bearing in mind that the proportion of total energy usage in the UK that flows through National Grid’s infrastructure will rise dramatically if the transition is successful – that is a big “if” – and it’s a question of whether the forward dividend yield multiple of 5.9 adequately reflects that risk. A cautious buy.

Last IC view: Buy, 995p, 21 Sep 2023