Monopolies can make investors quite wealthy, and the FTSE 100 has a few to capitalise on. Normally, regulators don’t allow these types of businesses, but there are some exceptions. And with the lion’s share of the market in their pocket, it isn’t surprising they’re also quite popular.
A prime example of a FTSE 100 monopoly stock is National Grid (LSE:NG.) – the UK’s energy transmission infrastructure operator. It’s been one of the most popular UK stocks to own, and with a multi-decade-long history of consistently hiking dividends, the firm’s been a lucrative source of passive income.
However, management’s been shaking things up, and dividends suffered a cut. What’s on the horizon for this business, and how much can investors earn in dividends under the new status quo?
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Investing in critical infrastructure
The fact that almost every British household and business is dependent on National Grid is why regulators allow the firm to exist as a monopoly. Yet it seems even monopolies can run into financial troubles when becoming overly dependent on debt.
With interest rates sitting near 0% for over a decade, the firm used this cheap money to expand and improve. But with rates now aggressively higher in light of inflation, the group’s balance sheet shifted from healthy to problematic within a few short months.
To address the elephant in the room, management unveiled a radical overhaul of the entire business. A highly dilutive £7bn rights issue was launched, non-core assets are getting sold off, and the dividend’s been re-based. For existing shareholders this is painful news. But for prospective investors it may present an interesting opportunity.
Even with the dividend cut, the stock still yields a chunky 5.6%. So at the current share price, to earn £1,000 a year in extra passive income, investors would need to buy roughly 1,790 shares, worth just over £17,800.
That’s obviously not pocket change, but by steadily drip-feeding capital and reinvesting dividends in the short run, it’s possible to build this position over time. And since the firm intends to restart its dividend-hiking streak, a lot more passive income could be unlocked in the long run.
What could go wrong?
Executing a corporate restructuring of this size is pretty challenging and will undoubtedly come with a few headaches. However, let’s assume things go without a hitch. What are the main threats investors must consider?
Despite being a British business, around 40% of profits actually originate from the US. That means the company’s performance is ultimately tied to gas and electricity demand both at home and across the pond. If a recession comes along, demand’s likely to suffer. This international exposure also opens the door to currency exchange risk.
Another threat is the state of pensions. The group currently has £17.9bn of pension liabilities on the books. The good news is that despite all the financial turmoil, there’s a surplus of pension assets, preventing a deficit that would harm profitability. However, should asset prices suddenly decide to tumble again, this balance may shift in the wrong direction.
When deciding whether National Grid shares are worth adding to a portfolio, investors will have to weigh these risks with the potential reward of lucrative long-term dividends.
