Savvy investors may want to add National Grid (LSE: NG) to their holdings, even if NG shares hover around record highs. Here’s why.
The Best Pick
One of the best picks in the utility sector, with a dominant position domestically, National Grid has ambitious plans in the US. Diversification is key to shareholder value in this industry, in my view.
Financially, National Grid is much stronger than smaller utilities in the UK. It also offers more value than Centrica and Severn Trent, for instance. Its shares change hands at around 920p, but a one-year price target of 1,100p makes a lot of sense.
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After a stellar performance in the last 12 months, and ahead of half-year results which are due on Friday, analysts believe its rally is about to come an end, however. Are they right?
Trading Above Fair Value?
Earlier this week, Exane BNP Paribas told its clients that the shares of NG traded 10% above fair value.
The broker reiterated a price target of 830p, which is 3% below the mean for consensus estimates of 856p. Based on several metrics, the argument goes, NG stock is overpriced and is likely to underperform the wider sector both in the UK and Europe.
Interest Rates & Utilities
“Utility stocks are widely perceived as long duration interest rate proxies and when interest rates rise, utilities are expected to underperform,” Exane BNP Paribas added.
This would hold true at an economic juncture characterised by substantially higher interest rates — and if the real economy were growing at a sustained pace. But in this environment, a significant rise in interest rates is highly unlikely, in my view. Of course, another element supporting a bullish view on NG stock is a dividend yield north of 4%.
Just as I argued in June, when NG stock traded at 834p, a fair value of 1,000p is not overly optimistic. Back then, the average price target, according to analysts’ estimates, stood at 825p.
Estimates: A Catch-Up Game?
If NG stock reverts to its one-year mean, as several analysts suggest, it would trade on a forward price to earnings multiple just below 16x.
In the last 52 weeks of trading, consensus estimates had to catch up with a surging stock price, which has bucked the trend of a declining stock market, having registered an impressive +18% performance. The mean for consensus estimates has risen by about 10% from 784p in October 2013.
Assuming National Grid reports earnings per share of 60p in the next couple of years, which is realistic, and based on a slightly higher trading multiple of 17x, NG stock would be valued at 1,020p. National Grid, however, could easily surprise the market with higher earnings, while its relative equity valuation could deserve a higher premium, or both. Hence, a share price target of 1,100p!
