As storm clouds hover over the UK economy, investors are turning up their noses at growth stocks in favour of companies that pay dividends. National Grid (LSE:NG.) is what I would describe as a dividend champion. Since 2000, its dividend per share has risen nearly 400%. But can it sustain this into the future?
Energy transition
In its half-year results released today, National Grid reported a 50% increase in underlying operating profit to £2.1bn. This was mainly attributable to new revenue streams from the acquisition of Western Power Distribution (WPD).
The company also updated on its investment framework to 2026. It now expects to invest £40bn in critical infrastructure. The vast majority of this investment (73%) will be in the decarbonisation of energy systems.
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The acquisition of WPD provides it with exposure to electricity distribution, which I see as a significant growth area.
The rise of renewables is altering the generation mix. But it’s also leading to the production of electricity being pushed down to a more local level. I envisage a future where end consumers not only consume electricity but trade it too.
In addition, electricity demand profiles are changing rapidly. Today, there are 10bn smart internet-connected devices. By 2040 this figure is likely to be over a trillion. The widespread uptake of EVs and heat pumps is also key. NG is likely to be a key player as this new electricity market emerges.
Dividend sustainability
National Grid offers a very progressive dividend. It’s committed to growing it in line with the retail prices index including housing costs (CPIH).
It has announced an interim dividend of 17.84p per share. That represents a 4% increase on the same time last year. For 2022-23, the dividend per share is expected to total 54p. That equates to a yield of 5.5%, well above the 3.9% FTSE 100 average.
However, analysts are becoming increasingly concerned about the sustainability of its dividend. The degree of capital investment required to make the energy transition a reality is likely to put a squeeze on future margins.
Enjoying monopoly status, National Grid operates in a highly regulated environment. Its distribution business is presently in negotiations with Ofgem over funding arrangements for the next five years. Ofgem’s final determination is due in December; however, at present it’s recommending a reduction in total capex allowance.
The company also has a very high level of debt. It currently stands at nearly £43bn. On its own, that isn’t a huge concern. It’s common throughout the industry. The problem is that as interest rates rise, servicing the index-linked part of the debt increases.
Why I bought
National Grid’s share price has come under pressure recently. Since May, it has fallen 20%. The possibility of winter blackouts is a contributing factor here. NG has responded by offering customers rebates for using electricity at off peak times.
I see such schemes growing rapidly. This is because as explained above the number of consumers trading electricity in the future will rise.
In a uncertain times, I’m looking for reliable sources of passive income. I’m also looking for a relatively risk-free way of gaining exposure to the fast-growing renewable space. For me, National Grid offers this. That’s why during its recent share price weakness, I bought some of its shares.
