Back in 2010, National Grid (LSE: NG) (NYSE: NGG.US) investors faced the choice of being diluted in a £3.2bn, 2-for-5 rights issue, or of stumping up extra cash to shore up the finances of their debt-laden company.
Investors who took up their entitlement in the rights issue have done well — the firm’s dividend has risen by 24% since 2010, while its share price has risen by 65% since July 2010.
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What’s more, National Grid’s lack of retail exposure in the UK means that unlike SSE and Centrica, it has avoided political threats of arbitrary price caps following the next general election. While Centrica’s share price is down by nearly 10% since Ed Miliband’s ‘price freeze’ speech last November, National Grid’s share price is up by 5%.
Too good to be true?
The trouble is, I’m not convinced that National Grid will continue to lead such a charmed existence.
The firm’s forecast earnings have been revised downwards continuously since May last year, and its dividend growth has now been pegged firmly down to RPI inflation, which suggests that growth of 3% per year will be the new norm, unless inflation takes off again.
What’s more, National Grid currently trades at nearly 16 times its forecast earnings for 2014. That seems expensive to me, for a firm whose earnings per share have grown by an average of just 3.2% per year since 2008.
What about the dividend?
Of course, the peg that is holding National Grid’s share price up is its inflation-linked 5.2% dividend yield.
Although this is attractive, my concern is that the combination of National Grid’s interest and dividend payments could become too much of a burden — National Grid’s interest payments totalled 21% of its operating cash flow last year, compared to around 8% for both Centrica and SSE.
National Grid’s net gearing is now almost 200%, and although regulatory price controls protect the firm from rising debt costs to some extent, I’m still worried that National Grid’s lack of free cash flow could eventually put pressure on its dividend.
Time to take profits?
Long-term income investors with a ‘buy and hold’ portfolio should sit tight, but if you are aiming to lock-in the long-term gains in National Grid’s share price, I believe that now might be a good time to take some profits, before the uncertainty facing the energy market starts to affect National Grid.
