Blogging Update

To skip the blog/life update to go straight to the stock analysis click here.

Having been pretty inactive on the stock market as of late, I finally picked up some shares in National Grid.

For followers of this blog, this article has been a long time coming as I haven’t posted in what feels like forever!

In September of this year I started a PGCE (teacher training) course with the hope of fulfilling my long term  aspiration of becoming a teacher, after all, this was the whole reason I started my university journey to begin with.

But – it’s been far tougher and time-constraining than I ever anticipated.

It’s safe to say that the hours are longer and the work a lot more demanding than my wildest imagination  – naivety perhaps.

The sheer demand on my time has meant that I have barely had time to meet and socialise with friends, let alone upkeep my beloved blog.

Despite this, I have managed to keep my portfolio in order and my dividend income for this tax year has just peaked above £300 for the first time (with 3 months of dividends to go!)

Not to bore you with negativity, I do have once piece of exciting news – Starting September 2018 I will be taking my first step in a new career direction.

When I started investing I was just frustrated with the terrible savings rates on offer and wanted to earn extra cash.

I wasn’t really that interested in business, enterprise or the stock market as such, this was simply my vehicle to achieving some decent return on my savings.

But, what started as a hobby and some painful investment losses has turned into my core passion.

I now spend hours upon hours (albeit much less since beginning my PGCE course) researching stocks and acquiring investment knowledge.

I now feel like it’s the time to take that leap into getting some accreditation for this acquired knowledge and to learn much more about stocks – more precisely the underlying businesses that these stocks represent.

I’m therefore HUGELY excited to have been accepted to study a MSc in Finance and Business Analytics starting in September 2018.

It’s safe to say that I have been routinely humbled by many of my peers who have completed such a qualification and it is through being humbled that I have aquired most of my stock market knowledge – turning from a sheep following the investment advice of other bloggers to taking independent stock purchasing decisions.

Here’s hoping to acquire some serious knowledge come September – knowledge that will no doubt improve my investment decisions and the value of this blog to readers.

In short – I look forward to being humbled further.

Some essential news to readers is that I will now be posting an article every Monday – a new year’s resolution I expect to stick to – This early article being the first in my string of 52 posts for the year. 

Anyhow – it’s time I stop rambling, let’s take a look at my most recent purchase – 59 shares in National Grid!

I purchased these shares of National Grid (NG.) for an average price of close to 880p a share with these shares adding £27 to my yearly dividend income.

National Grid is currently trading close to a 52-week low of around 850p and to me, this represents a ‘good’ price for a very predictable company that has a great track record of consistently raising its dividend.

National Grid plc is an electricity and gas utility company focused on transmission and distribution activities in electricity and gas in both the United Kingdom and the United States. The Company’s segments include UK Electricity Transmission, UK Gas Transmission, United Kingdom liquefied natural gas (LNG) storage activities;, and US Regulated activities.

In short – National Grid makes sure you can turn your lights on and fire up your gas stove!

At a 5.2% yield – I’m a buyer of this great utility company, but, I don’t expect much capital appreciation from here with shares only marginally undervalued at a 18.24 p/e or a more generous 15.11 p/e if we use the manipulated ‘adjusted EPS’ figure that management is touting – this is compared to an industry average p/e of a touch over 19.2 p/e.

So why are National Grid shares trading at a discount vs the industry?

Utility stocks have been HAMMERED as of late and I feel that there are two people driving this sentiment.

Mr Corbyn and Mrs May.

In Labour’s recent election manifesto Mr Corbyn promised to;

“Take energy back into public ownership to deliver renewable energy, affordability for consumers, and democratic control”.

If this were to happen – National Grid could likely be bought out by the government at it’s Net Asset Value of 497p a share thus meaning investors would lose close to 50% of their initial investment.

Yup – that’s spooky!.

This wasn’t really a possibility – I mean Corbyn was unelectable right?

That’s until May limped to victory and now has to rely on support from the Democratic Unionist Party to govern.

As we can clearly see from the below chart – the share price has declined steadily following the political earthquake following its prior large drop in May due to the stock going ex-dividend on its 87p special dividend.

Surprisingly May is seemingly keen to abandon the neo-liberalist principles of the modern Conservative party by introducing an energy price cap which I argue would have a knock-on effect on National Grid shares due to lower industry profits.

On top of this ‘market noise’ – there are also more concerning fundamental factors behind the current drop – 2017 was down 2.30 pence on the year prior (although adjusted EPS jumped 8.9 pence to  after weak results in 2016 – adjusted EPS now sits at levels similar to 2015).

The current half-year results are also slightly disappointing with operating profit and EPS taking continued significant hits when compared with 2016.

So why buy?

1. National Grid is currently in transition.

After selling two-thirds of its UK gas supply business National Grid is now looking towards the states.

I believe this transition has thrown of earnings in the last few years making National Grid shares appear weaker than reality.

2. National Grid has committed to buying back £835 MILLION pounds worth of its own stock with proceeds of the sale of most of its gas division which will boost EPS over the long term and provide a little more room to grow the dividend.

3. National Grid is that it’s a defensive dividend stock that operates in an industry where demand isn’t going to disappear overnight. We’re always going to want to turn the lights on! – Expect National Grid shares to hold generally firm during a recession.

4. Regulation, regulation, regulation! National Grid operates in a highly regulated industry which provides a high barrier to entry to competition.

The dividend

Any long-term reader of this blog will know by now that I love nothing more than a big fat juicy dividend and with a 5%+ yield I’m a happy investor.

But is this a growing dividend?

You betcha!

National Grid’s dividend policy is to growth the dividend by at least the rate of inflation. This has resulted in a very reliable yet very uninspiring 2% 5-year dividend growth rate and a recent 2.1% increase to the interim dividend.

The dividend is currently covered by earnings at a rate of 1.3 times which would be a close shave for most businesses but this is a highly predictable, wide-moat, recession-proof business with a long history of dividend raises bar a disappointing 3 pence cut in 2011.

But, by taking a close look at National Grid’s Free Cash Flow we can see that the company’s regulatory obligations to invest significantly in its infrastructure leaves it with little room for maneuver in 2016.

2017 FCF came in at 1725m with 1463m of this being paid as a dividend.

Conversely

2016 FCF came in at a healthier 2699m with 1337m of this being paid as a dividend.

Bearish points

This neatly brings me on to the bearish points;

  • National Grid is aggressively investing in North America and infrastructure is expensive and as such, I can’t see the squeezing of National Grid’s FCF going away anytime soon. As such, it is likely that National Grid will have to issue new debt in order to both maintain the dividend (of which I’m confident they will do) and to fund capital expenditure.
  • National Grid’s share price is sensitive to interest rates as it is most generally held for income –  any rise in UK interest rates will likely lead to a short-term decline.
  •  National Grid’s North American operations are thus far proving less profitable than its UK   operations which is worrying given management’s tilt to the States. (Return on invested capital in the states is 2-3% lower than in the UK currently).

Valuation

Morningstar currently has a 990p price target for National Grid shares.

Using the bottom end of management’s 5-7% long-term EPS growth target and a 10% discount rate – a dividend discount valuation models gives me a fair value estimate of 1092p.

Given the attractiveness of the current yield and the slight discount to fair value – I rate National Grid shares an INCOME BUY as a stock that fits nicely into the ‘core holdings’ of my portfolio.

But investors need be patient. Don’t expect much capital appreciation over the short to medium term, this is an income play.