Advertisement

Shares in focus: A dependable dividend-payer

This utility company pays out better than bonds for just a little more risk, says Phil Oakley.

National Grid pays out better than bonds for just a little more risk, says Phil Oakley.

Many people rely on income from investments. In a world where interest rates have been held at rock-bottom levels for four years, finding decent levels of income without taking lots of risk has become more and more difficult.

Advertisement - Article continues below

Given this backdrop, it's hardly surprising that investors have turned to utility companies' shares. As we all need gas, electricity and water, these companies have reliable income streams, allowing them to pay chunky dividends.

A dependable dividend-payer

National Grid has been able to pay bigger dividends for many reasons. Firstly, it has done a good job of running its regulated British gas and electricity networks. Despite the regulator, Ofgem, capping charges to customers, National Grid has invested a lot of money in its transmission and distribution assets. This has seen its regulatory asset value (RAV) grow a lot, which has allowed it to make more money as profits are a function of assets multiplied by the allowed rate of return on them.

Advertisement
Advertisement - Article continues below

It has also kept a tight lid on costs and spent less than its regulatory allowances. This has boosted profits and helped it make more money than the regulator expected. These extra profits have been paid out to shareholders.

Advertisement - Article continues below

National Grid has also taken advantage of low interest rates and taken on cheaper debt, enabling it to increase the difference between what it earns on its regulated assets and what it pays to lenders. That's been good news for shareholders too.

Can it keep paying out?

National Grid has £22bn of debt. This will keep rising as its British and American businesses have big investment requirements. While this will let profits grow, a bigger share will go to lenders rather than shareholders. Will there be money left for bigger dividends? Another concern is that the American business has regularly earned less than its regulatory allowance. It often asks permission to raise bills to make up the difference.

There's also the worry of rising interest rates. The firm must raise around £3bn of fresh debt each year to finance new investment and repay existing borrowings. Rising rates would make this pricier. But it's also a problem for the share price. Utility stocks are good substitutes for bonds because of their dividends. Rising bond yields and falling bond prices could see National Grid's share price fall too. In short, there's rarely a free lunch in investing but that's why the shares yield 5.5%. On the upside, management is confident its dividend growth target can withstand most events. It also has a lot of regulatory clarity as it has just entered an eight-year price control in Britain.

So if dividends can grow in line with inflation, then I can think of worse homes for your money. National Grid's shares could resemble an inflation-proofed bond, albeit with a little more risk. UK government index-linked bonds currentlyhave a real yield of minus 0.5% (0.5% less than inflation). With RPI inflation at 3.3%, National Grid yields 2.2% more than inflation (5.5% less 3.3%). Some premium is justified, but the shares look worth buying at current levels.

Verdict: buy for dividends

The numbers: National Grid (LSE: NG)

649_P10_National-Grid

Key facts

649_P11_Nat-Grid-divs

Directors' shareholdings

Advertisement
Advertisement

Recommended

Share tips of the week
Share tips

Share tips of the week

MoneyWeek’s comprehensive guide to the best of this week’s share tips from the rest of the UK's financial pages.
17 Jan 2020
Share tips: eight stocks that should deliver robust returns
Share tips

Share tips: eight stocks that should deliver robust returns

Ryan Ermey of US publication Kiplinger’s Personal Finance chooses his favourite stocks for the next decade, which should be able to grow for years.
28 Dec 2019
Share tips of the week
Share tips

Share tips of the week

MoneyWeek’s comprehensive guide to the best of this week’s share tips from the rest of the UK's financial pages.
20 Dec 2019
Share tips of the week
Share tips

Share tips of the week

MoneyWeek’s comprehensive guide to the best of this week’s share tips from the rest of the UK's financial pages.
13 Dec 2019

Most Popular

Eagle Lightweight GT: the reincarnation of the E-type Jag
Toys and gadgets

Eagle Lightweight GT: the reincarnation of the E-type Jag

Jaguar’s classic E-type sports car has been reinvented for the modern age. The result – the Eagle Lightweight GT – is a thing of beauty.
7 Aug 2020
Platinum: the precious metal that looks set to play catch-up with silver and gold
Silver and other precious metals

Platinum: the precious metal that looks set to play catch-up with silver and gold

Gold and silver continue to soar, but there's still time to get in. And there's another precious metal that looks set to go on a bull run too, says Jo…
7 Aug 2020
UK house prices hit a new record high – can it last?
House prices

UK house prices hit a new record high – can it last?

Despite the pandemic, UK house prices have hit a new high. John Stepek looks at what’s driving the surge in prices, and what it means for house prices…
7 Aug 2020