Analysis: National Grid’s interim results – flat as a pancake

In recent days, stock markets worldwide have been driven by the dramatic victory of the controversial Donald Trump in the US presidential election.

For many market professionals, there is real doubt about what policies will be implemented when he assumes the Presidency in January.

On Wednesday, the UK stock market plunged initially before recovering, with utilities – as defensive stocks – being solid performers.

A day later, National Grid, one of the EU’s most valuable utilities, announced its interim results for 2016/17, which were described by chief executive John Pettigrew as “good”.

However, the market disagreed: National Grid’s shares plunged by over 6 per cent on the day.

In fact, the underlying numbers presented were those of an archetypal utility; they were as flat as a pancake.

Revenues were up by 5 per cent at £7.2 billion; they were split 52/48 between the UK and US.

However, the underlying operating profit at £1.85 billion was almost identical to the comparative figure for 2015/16.  

Importantly, finance costs were higher at £562 million, compared with £499 million, with the falling pound being a major factor.

At the earnings per share level, the underlying figure was 28.2p, which mirrors exactly that of 2015/16.  

The overall tax rate was 22 per cent, the same figure as last year – and way above the tax level that many UK utilities, notably some water companies, are currently paying.

Investment at over £2 billion was up by 12 per cent on the previous year, as enhanced capital expenditure is being undertaken in the US.

Along with the more pronounced impact of the falling pound, the investment increase was partly responsible for the pronounced rise in net debt which rose sharply to £29.2 billion compared with £25.3 billion at March 2016.    

For investors, the ongoing pledge to increase dividends by at least the rise in the Retail Price Index has again been honoured, with a proposed interim dividend of 15.7p.

However, with dividend cover low, there are some concerns that flat underlying earnings, such as those just announced, will prevent future dividend growth.  

Drilling down into the accounts shows that the operating returns from the core businesses, except UK gas distribution, all rose.

The electricity transmission division was the star performer, with operating profits up 14 per cent at £697 million compared with £610 million previously.

Returns from the US also showed a substantial improvement with operating profits at £435 million compared with £351 million previously.

The only significant downturn was on profits from the French interconnector which, at £35 million, were well below last year’s one-off figure of £81 million.

Inevitably, the market remains very interested in the ongoing efforts to sell a majority stake in the gas distribution business, which – in total – is valued at over £11 billion. National Grid expects to complete this deal early next year.

Importantly, National Grid has reaffirmed its intent to return “substantially all the net proceeds” to shareholders. In the light of the very sizeable proceeds generated by sales of similar utility businesses in recent years, investors will be expecting a bumper pay-out.

Given the crucial nature of Ofgem’s eight-year RIIO settlement, which expires in 2021, National Grid reiterated that, following Ofgem’s mid-term review, there would be ‘no change to the key financial parameters’ – and, most especially, to the pivotal weighted average cost of capital (Wacc) assumption.

There will be, though, some relatively minor adjustments to certain aspects of the regulatory settlement.

Across the pond, National Grid has some important unfinished regulatory business.

In particular, its energy operations in both New York and Long Island are the subject of a major regulatory review. In total, these two businesses supply 1.8 million gas customers.

Recently, National Grid settled its outstanding regulatory issues in Massachusetts where it was awarded a 9.9 per cent return of equity.

Outside its own financial affairs, National Grid has a raft of other responsibilities. In particular, in the UK, it is effectively charged with ensuring that the lights stay on, despite very low plant margin levels.

Recently, it has struck various deals, which aim to lower the risk of power cuts, especially if a ‘cold snap’ is accompanied by several plant outages.

More immediately, though, the market will be focusing on the big numbers in National Grid’s interim results. Whilst there were no major surprises, the market was disappointed by the combination of flat underlying earnings and a sharp rise in net debt – as the share price reaction indicated.    

Looking forward, National Grid does face various challenges ranging from keeping on the lights this winter to managing an annual investment programme which is costing well over £3 billion.  

The outlook for US interest rates is also key, since investment in National Grid is a near surrogate for investing in 10-year bonds.

Whether US interest rates rise again once Trump assumes the Presidency  remains to be seen. But investors will be understandably nervous that the Federal Reserve’s interest rate policy may change under a new administration.

And, more parochially, National Grid will be careful to ensure that its New York business does not foul up; irrespective of the Trump Tower headquarters building, the President-elect has other private homes on their patch.