I like the passive income I can earn from owning shares. One popular dividend share for many small investors is power distributor National Grid (LSE: NG). In many ways I think the appeal of the National Grid dividend is clear. Demand for power distribution is resilient and likely to stay that way for decades. The company has a unique network that gives its business the sort of competitive advantage Warren Buffett calls a ‘moat’.
There are two sides to every story, however. So although I like the income potential of National Grid, I have also been thinking about some reasons for me not to invest in the shares. Here are a couple.
Lots of income opportunities
Currently, the stock’s dividend yield is 4.8%. That is attractive to me.
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However, in this inflationary environment, there are lots of other dividend yields that are also attractive. Legal & General offers 8.4%, British American Tobacco has a 7.8% yield and Anglo American is at 6.4%.
Like National Grid, they are well regarded FTSE 100 companies, each one with some competitive advantage in its respective industry. Buying them would offer me better income prospects than National Grid, if dividends are maintained (which is never guaranteed).
When a lot of companies had low yields, the National Grid dividend looked more attractive to me than it does in today’s market, where share price falls have pushed up the yields of some excellent businesses.
Dividend sustainability
I mentioned above that dividends are never guaranteed. That includes the payouts at utilities. SSE, for example, cut its dividend in 2020 and this year’s interim payout remained below the 2019 level.
Although a power network with monopoly characteristics seems like a license to print money, the reality is more nuanced. Pricing is regulated. Maintaining a network can be costly even if usage stays the same. But as power demand and sources evolve, the UK’s power grid may require considerable capital expenditure to keep it up to date.
Last year, National Grid saw net cash outflow from continuing operations of £1.6bn. The prior year’s figure was £2.9bn. In those two years, it funded £2.3bn of dividends. Not paying those would have halved net cash outflow at a stroke.
National Grid’s cash flows have been boosted by borrowing. Last year, net debt surged 50% to £43bn.
Partly that reflects borrowings to help fund an acquisition that could improve earnings. But at a time of increasing interest rates, such a bloated balance sheet makes me uneasy. As debt rises, I see a higher risk to the ultimate sustainability of the dividend.
I’m not buying
For now, I see no specific risk to the dividend in the short term. It has grown consistently for over two decades.
But in the end, it is hard to maintain a dividend without positive free cash flows. National Grid’s debt pile looks large to me. I can earn a markedly higher yield from other FTSE 100 businesses, some of which are carrying less debt. I currently have no plans to buy the shares.
