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Following the departure of the covering analyst, we are suspending coverage of National Grid, withdrawing our forecasts, target price and recommendation with immediate effect.
National Grid plc
The initial 2021-2026 £30-35bn investment plan unveiled in November 2021 which was transformed into ‘up to £40bn’ in November 2022 is now expected to be around £42bn. This represents a programme build-up to increase the asset base at a 8-10% CAGR and EPS at 6-8% while maintaining regulatory gearing in the low-70% range.
EPS guidance unchanged… NG has reported underlying 1H24 operating profit of £1,796m (INVe £1,777m, consensus £1,799m), underlying EPS of 23.8p (INVe 23.08p, consensus 23.1p), DPS of 19.4p (INVe 19.4p, consensus 19.1p), and net debt of £43.9bn (INVe £43bn, consensus £43.0bn). Excluding the accounting benefit in respect of the ESO, NG continues to expect full year underlying EPS to be modestly below FY23. Our pre-existing estimate of 67.8p, although under review, is 2.6% below FY23. The EPS outlook for the FY22-26 period remains at 6-8% CAGR. …but with moving parts at a divisional level UKET – net revenue is now expected to increase by around £260m (vs. previous guidance of up to a £200m increase) with costs expected to offset around a third of the increase (vs. depreciation to be around £50m higher previously). Our pre-existing estimates include ESO so cannot be easily compared, but NG’s guidance for the ESO is now around £30m higher (vs. £20m lower), with £50m lower depreciation as it is now classed as held for sale. Together this suggests we may well be light for NGET. UKED – net revenue is now expected to be modestly lower (vs. previous guidance of under £100m). Controllable costs are expected to be modestly higher (vs. around £30m higher), and the expectation for depreciation is slightly higher (vs. flat). US – the net revenue increase in New York and New England (ex NECO sale) is expected to be around $430m higher, compared to around $290m guidance at FY23, while other costs ex depreciation are expected to be around $170m higher, compared to broadly flat guidance at FY23. NGV & other – guidance for NGV is now around 5% lower (vs. 10% lower), with other activities still guided to just over £100m lower (vs. over £100m lower). This suggests we might be light on our estimates for NGV & other.
National Grid will announce 1H24 results on 9th November, hosting an investor call at 9.15am the same day. The recent pre-close update alluded to a broadly equal 1H/2H split of underlying operating profit in the UK regulated and National Grid Ventures businesses. The US is more seasonal, even more so in the New York business this year given a higher non-cash environmental provision charge. National Grid has guided to New York’s 1H underlying operating profit being in a 10-15% range of the full year. Our estimates are set out in Figure 1 overleaf. At the group level, we look for underlying 1H underlying operating profit of £1.78bn (-16.1%), underlying EPS of 23.08p (-28.8%), DPS of 19.40p (+8.8%), and net debt of £43.0bn.
Weighted towards 2H The briefest of pre-close updates from National Grid in respect of 1H24: “Overall, the group continues to perform in line with our expectations, and we expect underlying EPS to have a greater weighting to the second half.” Operating profit weightings across the group are expected to be more reflective of historic periods than 1H23. For the UK regulated businesses, contributions to operating profit are expected to be broadly evenly split across the year. In the US regulated businesses, contributions are expected to be more heavily weighted towards 2H. The New York business is expected to deliver 10-15% of its full year operating profit in the first half, given a higher non-cash environmental provision charge. In National Grid Ventures and Other, a broadly even split between 1H and 2H is expected.
Following BNPPE''s cross-sector strategy report on UK equities we revisit our views on Centrica, NG and SSE amidst a weakening UK economic outlook, substantially higher gilt yields, but optically cheap UK share prices. Are there some bargains to pick up in UK Utilities? Sadly, not really in our view - stocks haven''t de-rated much compared to other sectors, and suffer on the margin from higher gilt yields and election uncertainty, although we still see Centrica as an idiosyncratic Outperform. Picking apart the impact of changing UK macro conditions - on earnings, on valuation From an earnings perspective we expect UK utilities to live up to their defensive billing: We see limited EPS exposure to UK GDP, and fringe impacts such as bad debt and services risk for Centrica, and weaker USD for NG are relatively negligible from an investment case perspective in our view. But on valuation, macro is relevant, and we see some delineation on discount rate exposure In terms of gilt yield impact on valuation, Centrica is an outlier from a positive perspective in our view owing to its net cash position and short-duration earnings streams. For NG and SSE, higher discount rates on regulated activities should in theory be offset by higher allowed returns in the long-run, but the companies could suffer from negative timing mismatches (cost of debt allowances indexed over as much as 17 years), and allowed RoEs are less generous than they once were vs. returns available on bonds. SSE''s renewables business also suffers mechanically on higher UK discount rates and cost of debt, perhaps somewhat offset by lower-duration thermal earnings. Bottom-fishing in UK utilities? Nothing to get excited about in our view, except for CNA We remain bullish Centrica, whose special-situation characteristics are relatively unaffected by the shift in domestic macro. Nat. Grid is flat YTD despite the rise in gilt yields, does not trade at what we would consider distressed multiples, and...
NG/ CNA SSE
National Grid held an investor event focusing on their electricity distribution division yesterday afternoon. There were several company-specific financial and technical updates (see p2), and nothing to change our largely valuation-driven Underperform. But the more meaningful take from our perspective was on the looming impact of the decarbonisation of heating. We learned that electric heat pumps place 2.5x the strain on the electricity grid vs. EV chargers, and were reminded that half of all UK energy demand comes from space and water heating. Heat pump adoption has been slow to date, but this is a topic we think will gain increasing visibility with investors over the coming years. Heat pumps could be the next EVs ... eventually NG''s capex plan for FY24-28 in electricity distribution is up 30% vs the previous regulatory period. Some of this is driven by connecting new homes, but the big-ticket items are domestic EV charger installs and early-adopters of heat pumps. The EV charging topic is well-trodden but the heat transition less-so with investors in our view. And although the speed and pathway of widespread heat pump adoption (along with other clean heating technologies such as hydrogen) is uncertain, heating is a sector that must ultimately be decarbonised: across Europe, heating also accounts for 50% of energy demand, and 70% still comes from fossil fuels according to industry body Euroheat. What caught our eye from yesterday NG are expecting 10% annual growth from load and connections in their distribution network areas between FY23-28, with three quarters of this coming from EV chargers and heat pumps, which are expected to drive a 10% increase in energy demand over that period. The UK''s electricity distribution network was originally designed to meet c20% of national energy demand, but heating and EVs ultimately have the potential to consume significantly more than this. This is a trend that is not exclusive to NG, but is likely to be...
Press reports suggesting potential nationalisation of Thames Water due to spiralling debts have led investors to question general spillover risks for UK listed utilities. We don''t currently cover the listed UK water stocks, but observe that they have healthy balance sheets, suggesting low chance of financial distress spreading to the listed sector. For Centrica (+), National Grid (-) and SSE (=), we see limited fundamental readacross, and the companies'' bonds show no sign of a change in risk perception. If Thames is indeed temporarily nationalised that could dent wider investor sentiment, but we see negligible direct impact on CNA / NG / SSE and make no changes to our ratings or TPs. The financial readacross from Thames A major factor in the Thames situation is the historically higher leverage placed on privately owned water companies, but this contrasts with listed UK utilities which have remained more prudently financed during the age of low interest rates. Centrica is net cash, SSE recently guided to healthier balance sheet metrics on strong FCF amidst higher energy prices, and Nat Grid is well within its rating thresholds with a potential cash inflow to come from residual gas transmission sale. None of the companies'' bond spreads (see p2) show any signs of a change in risk perception. We also do not think the market was applying any significant MandA premium for these three companies which could be compromised by perceived lesser attractiveness of the sector to acquirers due to Thames. The political readacross from Thames Reports in the broadsheet UK press (e.g. FT, 28 Jun) have noted that neither of the two main UK political parties currently has appetite for the complexity and cost of systematically nationalising the UK utilities sector. Moreover for CNA/NG/SSE, the companies'' role in delivering on the decarbonisation ambitions of both parties might make it problematic for the govt to penalise them financially or via more stringent...
Updated estimates see EPS lowered by c.6-9% across FY24E-FY26E (Figure 1), a consequence of how capital allowances feed through to UK network regulation, and National Grid’s definition of underlying earnings. Our FY24E EPS is 67.8p, in line with National Grid’s guidance of underlying EPS being ‘modestly lower’ year-on-year. Our 5-year EPS CAGR to FY26E is 6.0%, the bottom end of National Grid’s guided 6-8% range, but consistent with company expectations of growth ‘expected to be towards the lower end…” There are moving parts in our valuation (Figure 4), but no change to our target price which remains 1,240p. National Grid’s equity story remains intact, and we continue to be attracted to a stock that is well placed to capitalise on the energy transition and increasing electrification. An investor event on 6th July showcasing National Grid’s Electricity Distribution businesses is a potential catalyst.
National Grid published strong FY22/23 earnings (year ended March 31) reaffirming the strength of its business mix during inflationary periods. The group completed its strategic pivot with the disposal of 60% of the UK Gas assets to focus mainly on electricity transmission/distribution over an intensive 2026 £40bn capex plan. The outlook over the five-year period 2020/21 to 2025/26 remains unchanged.
Counterintuitive tax accounting has muddied NG''s earnings outlook with the company now guiding below consensus on ''optical'' FY24 EPS, but suggesting it could reach top end of guidance by FY26 on an underlying basis. Although economically irrelevant, the result will probably be even higher multiples on FY24 consensus numbers, and we reiterate the mainly valuation-driven Underperform. Tax accounting creates a muddle The bottom line of the tax issue with guidance is that IFRS accounting forces NG to recognise future higher taxes, but does not allow it to recognise offsetting future higher regulatory revenue, thus artificially penalising FY24 EPS (see p2 for an explanation). Unfortunately these accounting incidents ,even if non-cash, do tend to impact share prices as seen e.g. with recent counterintuitive LNG contract accounting at Portuguese utility EDP, and we expect negative consensus revisions for NG. Electricity/gas mix in focus Guidance took much of the focus during the FY23 QandA but we also noted NG''s assertion that it''s happy with its current 70/30 mix of electricity/gas assets, seemingly playing down the notion of major asset sales in the US (where there has been recent press speculation over gas asset sales) and explicitly ruling out a sale of Grain LNG assets in the UK. The option window on a potential sale of the remaining 40% of UK gas transmission runs until July, and although they would not comment on likelihood of the sale occurring, use of proceeds would be on general capex if it happened. Also on the call ... 1) NG are advocating clarity from government amidst a political focus on regulation and net zero infrastructure, 2) company currently has 170GW of capacity in its grid connection queue, 3x current UK generation capacity, 3) finance cost increase at FY largely driven by index-linked debt. More detail here. We update for FY actuals and cut numbers by 9%, mainly to reflect the tax accounting But the impact reverses out by FY27,...
FY23 underlying operating profit in line consensus NG has reported underlying FY23 operating profit of £4,582m (INVe £4,488m, consensus £4,481m), underlying EPS of 69.7p (INVe 68.3p excluding National Gas Transmission, consensus 69.8p), DPS of 55.44p (INVe 55.58p, consensus 55.51p), and net debt of £41.0bn (INVe £40.9bn, consensus £41.3bn). UK Electricity Transmission (incl. ESO) reported underlying operating profit of £1,138m (INVe £1,149m, consensus £1,150m). UK Electricity Distribution reported underlying operating profit of £1,230m (INVe £1,152m, consensus £1,146m). New England reported underlying operating profit of £819m (INVe £691m). New York reported underlying operating profit of £874m (INVe £1,015m). Aggregate consensus for US regulated was £1,716m. NGV & Other Activities reported underlying operating profit of £521m (INVe £482m, consensus £482m). Presentation at 9:15am (HERE). Tax changes impact FY24 guidance, no change to medium term Forward guidance for FY24 points to underlying EPS slightly below FY23, whereas our estimate of 74.8p points to 7.3% growth. This is due to the change to the capital allowance regime from 1st April 2023 which NG expects to have a 6-7p/share impact on EPS, albeit with no economic impact over the long term. Without this change, underlying EPS was forecast to grow within our 6-8% CAGR range between 2022/23 and 2023/24, and consistent with our estimates, which do not yet reflect the change. NG has indicated that future earnings to FY26 are expected to remain within guidance of 6-8% EPS CAGR vs. FY21A of 54.2p. Excluding the equity stake in National Gas Transmission, which is accounted as discontinued from 31st January 2023, our pre-existing estimate is 6.1%.
FY23 guided in line with expectations National Grid has issued a pre-close update ahead of FY23 results on 18th May 2023. Performance is in line with NG’s expectations, and the expectation is for underlying EPS growth for FY2022/23 in the middle of the 6-8% CAGR growth range (INVe 6%). FY24-26 EPS CAGR impacted by tax changes, but economically neutral The UK Government has introduced 'full expensing' tax relief for capital expenditure from 1st April 2023 to 31st March 2026. This is economically neutral to NG, but is expected to impact underlying earnings from FY24-26. Expected lower cash tax payable will result in reduced revenues in UK Electricity Transmission and UK Electricity Distribution, resulting in a broadly neutral cash position. However, these impacts, alongside a corresponding increase in IFRS deferred tax liabilities, will result in a net adverse impact to statutory and underlying earnings. NG still expects to deliver underlying EPS growth of 6-8% CAGR across the five-year period from FY2022-26, but this is now expected to be towards the lower end of this range (INVe 7.2%). Further updates will be provided with detailed FY2023/24 guidance at the full year results. NGED investor event on 6th July An investor event will be held in London on 6th July 2023 to showcase NG’s Electricity Distribution businesses.
The EU has published its power market reform proposals. Having read through the big PDF outlining the measures (see Exane-annotated version here), everything looks in line with the leaks, except for a new clause forbidding disconnection of vulnerable customers, which could be moderately negative for suppliers. Lack of mandatory CfDs for hydro/nuclear is supportive for generators (e.g. Endesa, Fortum) but this had been widely leaked already, as had measures to promote CfDs/PPAs, which are a mild positive for renewables developers in our view (incl. Orsted, ELE, RWE, IBE, Enel, EDPR). The key proposals are on PPAs and CfDs The centrepiece is support for long-term power contracts for renewables: 1) govts would have to stimulate the Power Purchase Agreement (PPA) market including guaranteeing PPAs to make them accessible to smaller offtakers, and 2) govts would be allowed to offer price support to renewables projects so long as undertaken through fixed-price contracts for difference (CfDs) with the benefit of the fix passed to consumers in times of high prices. It''s unclear whether (2) would rule out further support via tax breaks under loosened state aid rules announced last week. Peripheral measures on end-pricing, resilience, trading, demand response, offshore 1) Govts would be allowed to set fixed tariffs during price spikes but must compensate suppliers for supplying below cost, 2) govts must ensure suppliers are properly hedged, 3) forward market liquidity should be improved via aggregation into virtual trading zones, 4) govts should stimulate demand response and storage, 5) offshore wind projects should be compensated for transmission bottlenecks, and 6) (new), vulnerable customers must not be cut off, which could raise bad debt risk for suppliers. What it means for the sector and next steps Lack of mandatory CfDs / fixed prices for hydro and nuclear is a relief for fixed-cost generators (ELE, Fortum), and PPA/CfD measures are moderately positive...
NG/ CNA EDP EDP ANA ANA NTGY SSE ENEL ENEL FORTUM VIE VIE RED ENG ENG EDF EDF SLR SLR EDPR EDPR ORSTED ORSTED SCATC RWE EOAN IBE IBE ENGI ENGI ELE ELE
Our updated estimates reflect the recent Ofgem AIPs, the ED2 final determination, NG’s 1H23 results, and revised macro assumptions. EPS forecasts move up by 6.1% in FY23E, but nudge down by 3.6% in FY24E and FY25E. We assume the recent US storms are classified as major and excluded from underlying EPS. Our 5-year EPS CAGR to FY26E is 7.2%, in line with NG’s guided 6-8% range. Our valuation point is rolled over to FY24E, and nudges down to 1,240p from 1,292p (Figure 8). This is due to a slightly higher WACC (4.4% vs. 4.3%), and a lower assumed premium to the US rate base of 60% (vs. 70%). For the UK regulated activities, our valuations suggest FY24E premia to RAV of 39% and 35% for transmission and distribution respectively. Pre-Christmas, Ofgem published a decision to implement a new Accelerated Strategic Transmission (ASTI) regulatory framework to fund the large strategic onshore transmission projects required to deliver the UK Government’s 2030 ambitions for energy security and 50GW of offshore wind. The framework will initially apply to c.£20bn (2021/22 prices) of onshore investment across 26 projects (Figure 4). These projects will be exempted from competition, and will be subject to a new reward/penalty ODI. The TOs are to submit updated project delivery plans including timelines and costs, but the ASTI framework is likely to see a material uplift in totex allowances. For NG, we estimate that this could be £10bn+ (2021/22 prices), with c.85% in RIIO-3. This is not included in our estimates, but we suggest that the inclusion of ASTI projects in totex allowances could be value accretive to NG, conservatively adding c.2% to our SOTP. With a potential c.30% 12-month total return on offer, we upgrade to BUY.
An encouraging set of half year results from National Grid, reflecting the resilience of the model in a challenging and turbulent macroeconomic environment, mainly driven by the regulatory frameworks and electricity transmission and distribution. National Grid upgraded its Capex guidance to £40bn between 2022 and 2026 to accelerate its transition to low carbon generation and enhancing its UK and US electricity distribution as well as the underlying EPS growing in the middle of the 6-8% CAGR range, to 32.4p.
Consensus beat, guidance up NG has reported underlying 1H23 operating profit of £2,117m (INVe £1,989m, consensus £2,020m), underlying EPS of 32.4p (INVe 30.24p, consensus 31.7p), DPS of 17.84p (INVe 18.54p, consensus 18.44p), and net debt of £46.5bn (INVe £41.8bn, consensus £41.7bn). NG now expects to deliver full year underlying EPS CAGR of 6-8% vs. flat guidance at FY22. Our pre-existing estimate of 65.3p, although under review, is flat YOY, but below consensus of a c.3% increase. The EPS outlook for the FY22-26 period has been increased to 6-8% CAGR from 5-7% CAGR. Potential positives across the board UKET – net revenue is now expected to decrease by £100m (vs. previous guidance of a £130m decrease) while other costs and depreciation are still expected to reduce. Our pre-existing estimates include ESO so cannot be easily compared, but given that NG’s guidance for the ESO appears to indicate higher underlying operating profit, we may well be light for NGET. UKED – With an acquisition impact of £230m and net revenue growth at c.£70m, we could be a little light in UKED. Previous guidance was for a FY WPD impact (acquisition on 14th June 2021) of £200m, net revenue up c.£80m, and higher controllable costs. US – the net revenue increase in New York and New England is expected to be around $475m higher, compared to around $440m guidance at FY22, while other costs are expected to be around $25m higher, compared to around $70m higher at FY22. Depreciation appears to be slightly higher than previously guided, but with $ strength, we see the combination as positive vs. our pre-existing estimates. NGV & other – higher sales in commercial property is a positive, complemented by the return to full service of IFA1, the first full year of NS1, and increased profits at Isle of Grain. This suggests we might be light on our estimates for NGV & other.
National Grid will announce 1H23 results on 10th November. The Rhode Island disposal completed on 25th May 2022, with the WPD acquisition completing on 14th June 2021. The former is included in 1H23 for two months, and the less- seasonal latter in for a full six months vs. 3½ last year. Additionally, c.75% of the £270m consideration for site sales to the Berkeley Group are expected in 1H23, while a stronger $ is supportive of the US business contribution. This points to a less significant 2H weighting than in prior years, and we look for underlying 1H operating profit of £1.99bn (+41.3%), EPS of 30.24p (+32.6%), DPS of 18.54p (+7.7%), and net debt of £41.8bn (see overleaf).
Increased renewables is widening the base-peak power price spreads, with 69% of total generation capacity from renewables forecast by 2030 per National Grid, and SMS’s EBITDA guidance for Burwell project recently increased to £57-65k/MW from £42-53k/MW from balancing services, with frequency services providing upside to this guidance. Batteries overcome limitations of traditional generation & storage with response times <20 milli-seconds, making batteries suitable for voltage and frequency fluctuations (coal, gas, nuclear turbines can take 12+ hours). SMS has 25 years’ experience with the relevant infrastructure. Our view: We believe that real assets - such as real estate, infrastructure and resource equities - have historically outperformed in inflationary environments and that batteries + meters should be considered as a new and important asset class in the current environment. We believe that SMS is backing a second winner in batteries, that may prove even more attractive than meters. We view Batteries as a one-way bet on increased uncertainty / mismatching of the supply and demand of energy; and both recent events and structural changes suggest that such imbalances can only increase on any realistic near or long-term scenario. It appears increasingly evident that the fundamental bet made c.20 years ago by management on meters, which ultimately built a £1bn+ company, is being made again, on a much larger, and far more remunerative scale. Greater yields and longer asset lives support this thesis, and, once again, SMS’s early mover advantage looks set to establish a barrier to entry and to sustain economic rents. Valuation: We restate our Buy and TP (70%+ FTR per our valuation model on page six). Trading update expected c.Jan’23.
National Grid plc Smart Metering Systems PLC
Our conviction that electrification is a clear direction of travel remains undimmed. Drivers include new generation build, electrification of transport, decarbonisation of heat, and an ambition to increase the level of interconnection with our European neighbours. We can only hope that the UK government, which has hitherto failed to address the cost of energy crisis and distributional fairness, is not bounced into making ill-judged decisions that increase investment risk, jeopardise investment, and put the target of decarbonising the power sector by 2035 at risk. Our estimates have been updated to reflect FY22 results, revised inflation estimates, revised exchange rate assumptions, the completion of the NECO disposal, an assumption that the sale of 60% of the gas transmission/metering business completes on 31/12/22, and the forward guidance provided last week. Excluding gas transmission/metering, we now estimate £32.8bn of capex across FY22-26E vs. £31.3bn previously. Our FY23E EPS estimate is cut by 5.8% (Figure 1), aligning us with National Grid’s ‘broadly flat’ guidance, but the inclusion of the retained 40% of gas transmission/metering in underlying earnings from 1/1/23 pushes up our outer year estimates. We estimate a 7.4% EPS CAGR through to FY26E, slightly above the upper end of National Grid’s guidance of 5-7% for this period. Our revised estimates see our valuation move up to 1,292p (Figure 4), and we increase our target price to 1,290p. This suggests a c.9% potential 12-month total return, and we reiterate our ADD rating.
National Grid confirmed its safe-haven status by unveiling a strong set of FY21/22 figures, c. 3.3% above the consensus. The group is moving forward serenely, benefiting from its natural inflation indexation both at operational and dividend levels. The mid-term FY25/26 plan is backed even if the FY22/23 outlook expected at ‘broadly flat’ is admittedly a miss. But who cares? NG is the perfect benchmark for a flight-to-quality for investors awaiting better times.
FY22 underlying operating profit beats consensus, in line with Investec estimate National Grid has reported underlying operating profit of £3,992m (INVe £3,980m, consensus £3,847m), underlying EPS of 65.3p (INVe 63.2p, consensus 62.4p), and DPS of 50.97p (INVe 52.2p, consensus 51.2p). Net debt was £42.8bn (INVe £44.1bn, consensus £43bn). UK Electricity Transmission (incl. ESO) reported underlying operating profit of £1,206m (INVe £1,206m, consensus £1,182m). UK Electricity Distribution reported underlying operating profit of £887m (INVe £808m, consensus £720m). US Regulated (New York, New England) reported underlying operating profit of £1,592m (INVe £1,680m, consensus £1,668m). NGV & Other Activities reported underlying operating profit of £307m (INVe £286m, consensus £292m). Presentation at 9:15am (HERE). Western Link revenue return to hit FY23 Forward guidance for FY23 points to broadly flat earnings vs. FY22, whereas our estimate of 69.3p points to 6% growth. At first glance, the impact appears to be due to lower expected revenues in UK transmission as a result of returning revenues for Western Link construction delays, and the revenue impact of UK capital allowance super deductions. The return of Western Link revenues is c.£150m, equivalent to c3.1p/share. If we adjust for this in our pre-existing estimate for FY23E EPS, we would be in the ballpark of ‘broadly flat’. NG has indicated that future earnings to FY26 are expected to remain within guidance of 5-7% EPS CAGR vs. FY21A of 54.2p.
Early return of interconnector revenues Including NSL which commenced operation in October 2021, National Grid has interests in five operational interconnectors, with a sixth (Viking Link) under construction (see Figure 1 overleaf). Three of the operational interconnectors operate under a cap and floor regulatory regime, a framework that sets yearly maximum and minimum revenues that can be earned over 25 years. The cap and floor are index-linked. Revenues are derived from auctioning capacity based on pricing differentials between markets, ancillary services, and the Capacity Market. Auctioning capacity represents the largest part. The 25-year period is divided into five assessment periods of five years, and revenues are compared against the cap and floor every five years, with no carry over between assessment periods. If there is a revenue shortfall, top-up payments are made to the interconnector licensee, and vice-versa if there is a revenue excess. In essence, this represents a timing difference as to when consumers fund or receive the benefit of revenues outside the cap/floor banding. At 1H22, National Grid alluded to an increase in auction prices across its interconnector portfolio, and interconnector profitability was an issue we flagged in our FY22 results preview earlier this week. The relevance of this as an issue has been underscored by a press release issued by National Grid this morning indicating that it has offered to pay £200m of interconnector revenues over the next two years, and ahead of the five-year review cycle. National Grid is working with Ofgem to explore how this early payment can have the most impact for consumers. It is not immediately clear how this will be accounted, but it does suggest that National Grid is expecting to be above the cap. £200m may be a small amount in the context of the overall increase in the cost of energy, but we view this as a very constructive approach from National Grid, and every little helps…
National Grid announces FY22 results on 19th May, hosting a presentation the same day at 9:15am. Registration HERE. Our detailed forecasts are set out in Figure 1 overleaf, with our estimates for National Grid’s key metrics being underlying profit of £3,980m (+21.2% vs. FY21), underlying EPS of 63.2p (+16.6%), and a dividend per share of 52.21p (+6.2%). Our net debt estimate is £44.1bn, 54.3% above FY21, reflecting the WPD acquisition, and the yet-to-complete disposals of the Rhode Island businesses, and the majority stake (60%) in the UK gas transmission and metering business. Of the many issues that face National Grid, which we suggest warrant discussion, we flag the exposure to inflation (we see this as a positive), the upcoming draft determinations for RIIO-ED2 (possibly as early as next month), the Future System Operator process, interconnector profitability, and the opportunities in the US linked to National Grid’s vision for fossil-free heat. We maintain a view that National Grid is well positioned to benefit from the push to electrify and decarbonise on both sides of the Atlantic. Longer-term drivers are also positive, and our 1,205p target price continues to support an ADD rating.
We remain convinced that electrification is a clear direction of travel, driven by renewables build, electrification of transport, and decarbonisation of heat, complemented by an ambition to increase the level of interconnection with our European neighbours. Our estimates have been updated to reflect the comments made by National Grid in last week’s trading statement, revised inflation estimates, revised exchange rate assumptions, and increased capex assumptions, with the latter now pointing to investment of £31.3bn for FY22-26E vs. £30.6bn previously. These support an increase in EPS of c.2-7% across our forecast period (Figure 1). With the sale of 60% of the gas transmission/metering business not set to complete until later in the year, and subject to regulatory/antitrust approvals, we retain it in our estimates as a discontinued operation. Adjusting for the sale, we estimate a 7.1% EPS CAGR through to FY26E, at the upper end of National Grid’s guidance of 5-7% for this period. Reflecting the agreed sale price for the gas transmission/metering disposal, the disposal of the St William property joint venture, and our revised estimates, our valuation moves up to 1,203p (Figure 4), and we increase our target price to 1,205p. According to Bloomberg, this is a street high. National Grid has delivered a c.36% total return over the past 12 months, and c.11% YTD, outpacing the FTSE All-Share Utilities Index in each case. With our target price pointing to a c.7% potential 12-month total return, we ease up a little and move to Add.
Higher operating profit in NGET/WPD to offset higher tax National Grid has published a pre-close update in respect of FY22, ahead of results on 19th May. There is no change to underlying operating profit guidance provided at 1H22 for the New England, New York, and National Grid Ventures (NGV and Other) business units. However, NG now expects to deliver underlying operating profit in its UK Electricity Transmission and Electricity Distribution business units above that guidance, largely driven by higher inflation. Offsetting this is a higher underlying effective tax rate (pre joint ventures) for FY22 of around 25%, due to an additional tax charge of around £100m reflecting the expected impact in the income statement of deferred tax reversing at a higher rate in the future. The underlying effective tax rate for FY23 is expected to reduce to around 23%. The net impact is that NG expects FY22 underlying EPS to be modestly higher than the guidance given at 1H22. We note that our pre-existing 62.16p FY22 EPS estimate is currently in line with consensus. Rhode Island sale completion now expected 1Q23 The sale of the Rhode Island business to PPL continues to make progress. All regulatory approvals have been obtained, but the Rhode Island Attorney General has appealed one of the approvals and NG now expects the sale to complete in 1Q of FY23. Rhode Island will continue to be reported within the New England business unit until the transaction completes. Our pre-existing estimates currently assume completion of the sale in FY22e. Clarifying accounting treatment on St William Homes and NGGT The gain on the sale of NG’s 50% equity interest in the St William Homes joint venture to The Berkeley Group (announced 15th March) will be reported as exceptional, while UK Gas Transmission and the legacy metering business will continue to be accounted as discontinued until the disposal of the majority stake closes, expected later this calendar year.
NGG sold at a c.30% premium to FY23E RAV NG has announced it has agreed to sell a 60% equity interest in its UK gas transmission and metering business (“NGG”) to a consortium (the “Consortium”) that comprises Macquarie Asset Management and British Columbia Investment Management Corporation. The terms of the transaction imply an enterprise value for NGG of approximately £9.6bn. On completion, NG will receive approximately £2.2bn in cash consideration (subject to customary completion adjustments), with NG subsequently owning a 40% minority equity interest in NGG via a new holding company called “GasT TopCo”. Additionally, NG will also receive approximately £2.0bn from additional debt financing at completion. At March 2022, NGG’s regulated asset value is estimated by NG to be c.£6.6bn and its net debt is estimated to be c.£3.8bn, implying a premium to RAV of c.30%, after adjusting for the £0.9bn value we attribute to metering. NG has also entered into an option agreement with the Consortium for the potential sale of the remaining 40% of equity in GasT TopCo, an option exerciseable by the Consortium between 1st Jan 2023 and 30th June 2023. If the option is exercised, the consideration for the 40% is expected to be paid in cash to NG on broadly similar terms to the transaction, subject to adjustment for dividends paid in the business at the time of exercise. Our pre-existing SOTP for NG values NGG at c.£9.3bn with a FY23E valuation point, albeit with an additional uplift for an assumed sale of 51% of NGG at a 40% premium, resulting in c.£9.8bn of value being included in our SOTP at FY23E. We suggest this is equivalent to a valuation of c.£9.4bn at a FY22E valuation point and, consequently, averaging out the sold/retained NGG in our SOTP, NG’s achieved price is broadly in line with our valuation. We expect that once completed, the transaction will lead to the equity contribution of NG’s 40% stake in NGG being included in NG’s underlying EPS metric, until such time that a complete exit is effected. The transaction represents a further step in NG’s pivot towards electricity.
Sale of St William JV Yesterday National Grid announced the sale of its entire 50% equity interest in the St William Homes LLP ("St William") JV to The Berkeley Group for cash consideration of £412.5m. Alongside the JV sale, National Grid and Berkeley Group have entered into a series of sale and purchase agreements for a number of additional sites owned by National Grid. These are expected to complete over the period to 2025 for a total consideration of approximately £270m. Deferred consideration of £230m in respect of sites previously sold to St William is also payable by Berkeley Group to National Grid over the period to 2031. c.0.7% benefit to valuation The St William JV is represented in National Grid’s income statement in two ways: (i) as revenue in ‘NGV and Other’ representing sales of property into the JV; and (ii) National Grid’s 50% share of St William’s post-tax earnings. There is no separation by National Grid of its fully consolidated property earnings between sales to St William and other, but the impact on earnings of the disposal is likely to be immaterial, in our view. Our sum-of-the-parts valuation values NG’s fully consolidated property interests (this includes the future sale of land to St William) at £355m, and we view this as consistent with the £270m referred to above. The deferred consideration in respect of the sites already sold is reflected on National Grid’s balance sheet. We value National Grid’s 50% stake in St William at book value, equivalent to £137m at 31st March 2021. The value obtained from the sale of the JV interest is therefore a minor positive to our valuation, at c.8p/share (c.0.7%). We welcome a non-core disposal We view the disposal as one of a non-core asset, and one that we welcome.
Electrification is a clear direction of travel, driven by renewables build, electrification of transport, and decarbonisation of heat, complemented by an ambition to increase the level of interconnection with our European neighbours. National Grid outlined an investment plan of £30-35bn for FY22-26 (Figure 1) at its November investor day. Our updated estimates incorporate £30.6bn, up from £28.8bn previously, but hinting at upside depending on the extent to which uncertainty mechanism totex flows through in the UK (Figure 2). Investment is likely to remain high beyond FY26, supported by the 40GW offshore wind target by 2030 (Figure 4), with more to come in the 2030s, proposals for multi-purpose interconnectors (Figure 5), and the ongoing need to invest in distribution networks to facilitate growth in EV charging, and electrification of heat. Our estimates have been updated to reflect FY22 guidance set out by National Grid at the 1H22 interims, the new reporting structure, Ofgem’s November 2022 Annual Iteration Process, revised inflation estimates, and our increased capex assumptions. These support an increase in EPS of c.4-5% across our forecast period (Figure 6), and when adjusted for an assumed sale of a majority stake in the UK gas transmission business, point to a 6.1% EPS CAGR through to FY26E, consistent with National Grid’s guidance of 5-7%. Our valuation point is rolled forward to FY23E, and our target price is increased to 1,135p (from 1,000p). Despite a c.20% increase in the stock price over the past three months, we suggest that there is further to go, and a 10% potential 12-month total return keeps us in Buy territory.
National Grid beat expectations at the EPS level (+8.6% vs consensus) for its H1 21/22 results, mainly driven by the WPD acquisition, higher regulated tariffs and the post-pandemic recovery. As a result, the full-year outlook was improved. The group also unveiled its 2026 roadmap: £35bn capex in networks, both in the US and in the UK, to increase the asset base and support the expansion of renewables. The plan is in line with our expectations, even if the funding issues were relatively unaddressed.
In-line with consensus, upgraded guidance NG has reported underlying operating profit of £1,407m (INVe £1,471m, consensus £1,402m), underlying EPS of 22.8p (INVe 20.93p, consensus 21.0p), DPS of 17.21p (INVe 17.51p, consensus 17.34p), and net debt of £41.5bn (INVe £42bn, consensus £40.5bn). NG now expects to deliver full year underlying EPS significantly above the top end of the 5-7% range, primarily driven by early commissioning of the NSL interconnector, coupled with higher auction prices across the interconnector portfolio, which is expected to deliver around £100m higher operating profit. Our pre-existing estimate of 59.97p, although under review, points to a 10.6% increase, and is in-line with consensus. Divisional outlook – ease of comparison clouded by new reporting lines UKET – cost increases are still expected to offset higher revenue, although depreciation is now expected to be flat. Our pre-existing estimates include ESO so cannot be easily compared, but given that NG’s guidance for the ESO appears to indicate broadly flat adjusted operating profit, we may well be light for NGET. UKED – NG has pointed to a typical 1H weighting of 45-50%, suggesting that the risks to our pre-existing forecast might be on the upside. US – revenue increase in New York & New England is expected to be around $220m higher compared to around £200m guidance at FY21, while costs are expected to be around $200m lower, compared to around £100m lower at FY21. This points to a slight benefit, as do comments on depreciation, albeit already captured in our estimates. NGV & other – the aforementioned interconnector is a positive, complemented by the commercial property business which is expected to return to 2019/20 level of performance.
Last week’s Net Zero Strategy was a clear endorsement of our view that electrification is the answer to many decarbonisation challenges, and further evidence that NG’s electric pivot is the right strategic move to take. NG hosts a capital markets day on 18th November, and we expect an electric bias, including NG talking in detail about WPD for the first time. A housekeeping exercise on our estimates sees our FY22E operating profit and EPS estimates barely changed, reflecting the opposing impacts of including WPD for 9½ months (vs. 8 months), and reclassifying the gas metering business as discontinued. Outer years nudge down given the metering accounting change, although assuming that a 51% stake in the gas business is sold at a 40% premium to FY22E RCV, our five-year EPS CAGR sits in NG’s guided 5-7% range. Our target price increases marginally to 1,000p (vs. 980p), with the UK regulated activities valued at premia of 24% and 34% to FY22E RCV for electricity transmission and distribution respectively (Figure 4). 3% of our valuation is represented by NG’s small pension surplus on an IFRS basis, which even if disregarded still points to a c.13% 12-month total return from current levels. NG is to publish its 1H22 results on 18th November, and we set out our expectations in Figure 3. With WPD included for the first time, NGGT and gas metering classified as discontinued operations, and Rhode Island no longer depreciated, there are many moving parts, in addition to comments made about seasonality in last week’s trading statement. We look for a c.28% increase in underlying operating profit to £1,471m, and a c.22% in underlying EPS to 20.9p.
Delivering the three steps of the electric pivot add a layer of complexity to estimating National Grid’s underlying earnings, particularly for FY22E. We present our estimates on the basis that WPD contributes for eight months, the NECO sale completes at the year-end, and that NGGT is classified as a discontinued operation for the full-year. Our FY22E EPS is cut by 20.9%; although, adjusting for the reclassification of NGGT, the reduction is lower at 10.5%. Further adjusting for the lower level of NGGT profitability within discontinued operations that we now forecast, our FY22E underlying EPS is c.7% lower than previously on a like-for-like basis. Our FY22E EPS estimate suggests growth of 10%, slightly more bullish than National Grid’s guidance of “growth towards or above top end of 5-7% range”. Our 5-year EPS CAGR is 4.2%, but this assumes that NGGT remains classified as a discontinued operation. National Grid’s guidance assumes the sale of a majority stake in NGGT, and the subsequent inclusion of the equity accounted contribution from the minority position in underlying earnings. Our estimates would fall in the guided range of 5-7% on the assumption that a 51% stake in NGGT is sold at a 40% premium to FY22E RAV. Our valuation (Figure 4) reflects many moving parts, but at a consolidated level, there is little change, and we finesse our target price slightly to 980p (vs. 990p). We remain of the opinion that the electrification drivers are intact, and that National Grid offers investors a multi-year growth story. We reiterate our Buy rating.
National Grid saw its adjusted operating profit down by 12% for the FY20/21 (fiscal year ending in March), especially driven by the adverse timing of recovery movements and COVID-19. These results are well below our (bullish) expectations. However, the network giant provided a promising 5-year guidance in terms of capex (£30-35bn to 2026) and EPS CAGR (5-7%). WPD / NECO / NGG deals are on track. Note also a surprising but pleasant JV with RWE to develop US offshore wind.
Slight beat on FY21 NG has reported underlying operating profit of £3,283m (INVe £3,214m, consensus £3,220m), underlying EPS of 54.2p (INVe 52.0p, consensus 52.1p), and DPS of 49.16p (INVe 49.59p, consensus 49.59p). Net debt was £28.6bn (INVe £29.7bn, consensus £30.9bn). See Figure 1 overleaf. The slight beat at underlying operating profit appears to be due to the Covid-19 impact out-turning at £355m vs. guidance of around £400m. This was further mitigated by the recognition of £59m for the commodity portion of some of the Covid-19 bad debts, while the debt beat vs. INVe is due to NECO debt of £1.1bn being reclassified as held for sale. Medium-term EPS guidance underpins attractions Forward guidance for FY22 points to cost and depreciation increases more than offsetting revenue growth in UKET (INVe has an operating profit increase), with a similar narrative for UKGT. For UKET, our estimates have slightly higher revenue growth, suggesting that we are light on both costs and depreciation. In the US, guidance is for a c.£250m increase in underlying operating profit (INVe has a c.£300m increase). Taken together, this suggests pressure on our FY22E operating profit for the existing business mix, but further comparison at a group level is clouded by the fact that our estimates include the assumed completion of the WPD acquisition at end-July. NG is guiding to an EPS CAGR of 5-7% (INVe 7.6%) over the five years to FY26, indicating that this will underpin a sustainable, progressive dividend policy. We do not view our estimates as inconsistent with NG’s longer-term view, as we would expect the sale of a majority stake in NGGT to dilute. We continue to see attractions in the NG equity story.
Grid asks for 8.8% ROE National Grid has filed a 3-year rate settlement back-dated to April 2020 for its downstate New York utilities KEDNY & KEDLI, which together represent c.29% of National Grid’s US rate base. It has proposed a return on equity of 8.8%, a debt/equity structure of 52%/48%, FY21 capex of $583m for KEDNY and $369m for KEDLI, and $3.3bn capex across the rate plan to March 2023. The proposal maintains tracker and true-up mechanisms for property taxes, commodity related bad debt, pension/OPEBs, and environmental remediation. It also provides a framework for advancing the infrastructure and non-infrastructure solutions identified to address long-term demand in downstate New York, and support for clean gas programmes including renewable natural gas and hydrogen blending. National Grid anticipates new rates effective in August 2021 with a make-whole provision retroactive to April. Bill impacts proposed are 0% in year 1 (to April ‘21) for both utilities, 2% in years 2&3 for KEDNY, and 1.8% in years 2&3 for KEDLI. The current allowed return on equity is 9%, and our estimates assume 8.7%. Figure 1: Key elements of proposal Source: Company Figure 2: Financing assumptions Source: Company
-10% EPS on Covid impacts and UK transmission We expect National Grid to report a -7% drop in underlying EBIT in 2020/21, driven by Covid impacts, particularly affecting the US as previously indicated, while UK electricity transmission (down -7% EBNPPe) should continue to see the effects witnessed already in H1 this year (slightly higher costs, including on Covid vs lower datacentre and cybersecurity allowances as well as lower ESO incentives). We forecast a similar -7% drop in underlying PBT, with financial charges being down YoY on lower interest charges, including with regards to inflation-linked debt. Underlying EPS should be down c.-10% YoY as a result. Focus on UK With regards to the UK, we foresee a (QandA) focus on the integration of WPD, the acquisition of which was announced two months ago, as well as on the ongoing appeal process against UK regulator Ofgem with regards to the allowed return granted under RIIO-2. Focus on US For the US, the focus is likely to be on the pace of recovery of Covid impacts as well as ongoing rate case discussions in New York. Conference call Thu 20 May 2021 at 9h15 BST. We do not view our estimate / target price changes as material; our rating is unchanged.
Network reshuffle Last Thursday, National Grid (NG) announced a significant 3-step transaction: NG will acquire Western Power Distribution (WPD) for an equity value of GBP7.8bn from PPL, which in turn will acquire NG''s Rhode Island business (electricity and gas) for an equity value of USD3.8bn (GBP2.7bn). In parallel, NG will launch the sale of a majority stake in its UK Gas Transmission as well as metering businesses in coming months (NGT). Increasing exposure to electricity, at the expense of superior US returns WPD runs the UK''s largest electricity distribution network. The transactions should raise NG''s exposure to electricity grids to 70% of NG''s assets vs c.60% today. NG highlights this enhances its role in the energy transition and, given the positive multi-decade outlook for electricity distribution, supports NG''s 5-7% asset growth target for longer. It will however slightly lower the weight of US operations (to 40% vs 46% of group assets today), where returns are typically superior. Limited changes to our earnings forecasts We have modelled the various transactions (assuming a full eventual exit from NGT) and tweaked upwards our expected allowed RoE''s under the RIIO-2 regulatory period although the latter is more than offset by a lower USD FX rate since our last update and our assumption of more progressive US tariff increases to contain impacts on consumer bills. Overall, our EPS forecasts are upped meaningfully in FY22e on phasing effects of the transactions but are little changed thereafter. We could notably see some upside should NG manage to bring down WPD''s financing costs. Lowering our valuation - deal could pay off longer term. We stay ''Outperform'' The c.60% EV premium to RAV paid by NG for WPD is twice as high as that reflected now in our SOP and is only partly offset by the attractive valuation on the Rhode Island sale (c.80% premium) while we assume an NGT sale at our SOP value (25% premium). That latter may prove...
National Grid has engaged in a significant asset swap with PPL Corporation to buy UK-based grid activities for £14.2bn (EV) and to sell US-based gas and electricity activities for £3.7bn. The group also plans the sale of its UK-based gas division and is thus shifting from a US growth-driven strategy to UK asset consolidation, and therefore moving towards greater exposure to the growing electricity market. A strategically promising move.
UK regulatory risk cleared - with positive option value UK energy regulator Ofgem published, as scheduled, its final determinations for electricity and gas networks'' RIIO-2 regulatory period (Apr-21 to Mar-26). The outcome is a marked improvement from draft determinations published in July on key issues including allowed returns as well as the visibility and financeability of investments. Although a relief in our view, such a framework still has positive option value from companies being able to selectively appeal specific items with the CMA. The 4.3% base allowed real RoE in particular could have room for further upside (by c.70bps). Raising our forecasts Capturing Ofgem''s review into our forecasts, we raise our adj. EPS mid-single digit over the next three years and see high single digit upside to pre-release consensus EPS, driven by lower financial charges rather than regulatory upside (EBIT broadly in line). A successful CMA appeal and/or capex acceleration on the UK''s de-carbonisation ambitions could drive further upside. Dividend policy seems sustainable We believe National Grid''s policy of growing DPS with inflation should prove sustainable also during RIIO-2 (although we continue to assume a switch to CPIH vs RPI indexation, in line with the switch in regulatory indexation), based on both payout and balance sheet ratios analyses. Attractively valued defensive energy transition play We raise our TP to 1,130p from 1,060p on our earnings upgrades and rolling forward of our valuation. National Grid group trades at the low-end of European network peers on premium to 2021e RAB (15% vs 12-23% range) despite incorporating US networks which offer both superior growth (7% RAV pa) and higher returns (and a currency hedge against Brexit). Valuing the US business in line with US peers, we assess National Grid UK trades at a discount of more than 10% to next year''s RAV, unjustified in our view as we see value creation potential under RIIO-2....
Mass Gas files for a 10.5% ROE National Grid has filed a request with the Massachusetts Department of Public Utilities (DPU) to update gas distribution rates for its Massachusetts Gas business. The rate filing is a five year rate plan that requests a $138m increase in revenue to cover increased operating costs and core investments, a Return on Equity of 10.5%, and a 53.4% equity capitalisation. National Grid is also proposing a new Performance Based Rate Mechanism (PBRM) that will link annual revenue increases to inflation. The filing also includes a request for significant investments of up to $50 million in innovative proposals to decarbonise Mass Gas’ natural gas networks, including hydrogen blending, shared geothermal loops, renewable natural gas, and demand-side response measures. These proposals would be recovered through existing regulatory mechanisms outside the requested revenue increase. NG expects the rate filing is expected to conclude in September 2021, with new rates effective 1 October 2021. The impact on typical residential heating customers will be 9% in the Boston service territory, and 9.5% in the Former Colonial service territory. The ROE ask is higher than the currently allowed 9.5% (53% equity capitalisation), and the 9.6% (53.5% equity capitalisation) awarded to Mass Electric in its 2019 rate case. Mass Gas accounts for c12% of NG’s US rate base. We see the filing as an opening request in a negotiation process, noting that NG requested a ROE of 10.5% in its Mass Electric filing, a 53% equity capitalisation, and $50m of incremental operating expense. The Mass Electric settlement allowed a ROE of 9.6%, 53.5% equity capitalisation, and $32m of operating expenses, with average bill increases for the typical customer of 2.0% vs. 2.6% in the filing. We consider the Mass Electric filing to provide a good read across to how the Mass Gas case might settle.
Fully valuing a capex supercycle... We previously highlighted the upcoming utility capex supercycle (UTILITIES: Capex supercycle), in which the c.EUR1.8tn European network capex by 2050 may merit more attention relative to the enthusiasm for renewables. In this note, we seek to calibrate company-specific long-term outlooks, with Red Electrica standing out on potential for acceleration, followed by Terna. Gas transmission grids (Enagas, Snam) could also see improved fortunes on a transition to green gases. ...will first require regulatory returns to trough Extending the duration of asset valuations may be complicated, however, at times of renewed reflation expectations (post-Joe Biden election). Persistent downwards regulatory resets, mirroring falling interest rates, also impede comfort in regulated utilities'' earnings growth even if we expect returns to remain value creative so as to support capex deployment. We only foresee a 1-2% EPS CAGR20-25e for European regulated network utilities from an average 4-5% RAB CAGR20-25e. Forecast changes We now incorporate a -60bps drop in allowed returns in Italy from 2022, driven by a lower country spread. We raise our assumed allowed RoE for National Grid under the ''RIIO-2'' regulatory period following the CMA''s review on the UK water sector. Incorporating other targeted modifications, we see upside to earnings expectations at Enagas, Italgas (despite the allowed return cut) and National Grid (medium term), while we see downside on Terna, and to a lesser extent Snam. Picking winners Those with earnings upside in our view deserve a premium thanks to a superior value creation outlook (Italgas raised to (+), National Grid (+)) or some respite from significant underperformance (Enagas upgraded to (+)). We have modelled Enagas'' associate stake in Tallgrass (US midstream) which, despite its well-identified challenges, should not induce a dividend cut at Enagas, we think. We downgrade Snam and upgrade...
NG/ RED SRG ENG TRN ELI IG REE
Press comment about Grid split… The Telegraph, with follow-up commentary from The Times, has commented that National Grid could be stripped of its role in managing the GB electricity system, with the former reporting that compensation for National Grid shareholders is being explored. …not new news & something we have covered in the past This is not new news. In September 2019, in the aftermath of the August power outages, we wrote (here) “that Kwasi Kwarteng (UK Energy Minister) has questioned whether National Grid should retain its Electricity System Operator (ESO) role. The ESO has been a legally separate entity within Grid since 1 April of this year, and National Grid was also required to take a number of physical measures (walls, separate entrance, etc.). At the time that Ofgem consulted on the separation in 2017, it invited views on greater separation, with some respondents calling for harder separation. Ofgem will be reviewing the effectiveness of the current level of separation in 20/21.” We have also posed the question to National Grid in the past, most recently on the National Grid’s RIIO-2 Draft Determination Consultation Webinar (link at 27.00), “Whether now is the right time to bring forward complete separation of the ESO from the National Grid…” The industry has changed, we see logic in the possible move Given the changing dynamics of the electricity industry, the challenges of plotting a route to net zero, the blurring of the boundaries that traditionally existed between various parts of the value chain, and the emergence of DSOs, we feel it is possible to argue that a different ownership structure, with the independence of the ESO that goes beyond the current legal separation, has merit. Furthermore, such a body could be a very powerful voice in helping to shape the future direction of the industry, free from any suggestions of possible conflicts of interest, however remote the latter might be. For National Grid shareholders, a full split if compensated at fair value, would not impact the equity case, and it is worth noting that the ESO’s RAV of £211m at March 20 is a fraction of the £14bn+ RAV for the GB electricity business at that time.
Lockdown restrictions and curbs on social freedoms are likely to impact economically sensitive stocks, pushing safer haven regulated names to the fore. Impending communication from the CMA and the ongoing RIIO-2 process will increase this focus. Ofgem’s Draft Determinations have knocked National Grid, and an intense battle is now raging ahead of Final Determinations in December. We have examined high level components of the Draft Determinations, and conclude that the allowed return on equity should be higher given a downward bias on asset beta, a flawed outperformance wedge, and our view that energy networks are riskier than water networks. We also believe Ofgem will move on baseline totex allowances, and suggest that the Net Zero re-opener might delay progress towards Net Zero. Our central case assumes a 4.33% CPIH real allowed return on equity at 60% leverage, the midpoint of the 4.70% suggested by our analysis, and the 3.95% proposed by Ofgem. This is lower than the 4.80% we previously assumed, and is the driver of a target price which falls to 955p from 1,030p. Using Ofgem’s Draft Determination of the allowed return would see our valuation reduce to 936p, while the 4.70% derived by our analysis would nudge it up to 971p. We acknowledge the uncertainties of the ongoing RIIO-2 process, the risks of the energy transition, and Covid-19-related pain shared across the energy value chain, but with National Grid’s shares down more than 10% since early July, we suggest they are worth another look. Buy rating retained.
NG/ PNN SVT UU/
RIIO-2 draft determinations - regulatory gymnastics UK regulator Ofgem yesterday published its draft determinations ahead of the ''RIIO-2'' regulatory period (starting April 2021). Ofgem sought to reconcile its known focus on affordability with UK''s enhanced decarbonisation pledges. It proved a complex exercise of further nudging down the indexed base allowed RoE to 3.95% real (from 4.3% proposed last year), taking a tough stance on ex-ante accepted capex but leaving large room for spending true-ups (up to GBP10bn incremental transmission capex seen as plausible) depending on upcoming energy policy decisions. There was pushback on the proposal''s fundability and appeal to invest, including from National Grid and SSE. National Grid singled out on quality of communication Overall, Ofgem''s baseline totex proposals in transmission stand some -45% below companies'' proposals, dragged down by a -50% cut for National Grid''s electricity and gas transmission plans. The company was singled out for insufficient justification of spending requests, contrary to peers. The ball is in the company''s camp to provide more evidence in the coming months, particularly on non-load asset health investments. Final determinations will be published in December. No material changes to our forecasts Ofgem''s allowed RoE proposal is close to our prior assumption (4%) while our cost of debt assumption was somewhat below the 1.74% proposed (real, indexed). We have however trimmed assumed RIIO-2 outperformance (c.50bps from 100bps on average) and allowed opex while we trimmed GT capex assumptions by 20%. Our overall EPS changes are immaterial though (-1%). Outperform recommendation reiterated At c.20% EV premium to RAV, National Grid trades in line with European regulated peers on average. We believe this fails to reflect superior value creation and growth from its US networks which now outweigh those in the UK. Valuing National Grid US aligned with US peers leaves no...
Ofgem is set to announce RIIO-2 draft determinations on July 9th, and we highlight six things to look out for. The cost of equity/allowed return are the headline grabbers, and we look for the outperformance wedge to be ‘retired’, and model using 4.8% CPIH real. We would view an indication of 5%+ as a positive. Cost of debt allowances may move to a longer trailing period than working assumptions, incentive mechanisms are an important route to topping up base returns, while asset lives and the fast/slow money split will influence the shape of earnings. Updated estimates reflect the impact of Covid-19, notably in the US where bad debts are likely to rise, costs will be higher, and rate increases deferred. Our FY21E EPS falls by c13%, and although we assume a progressive recovery, we have also trimmed EPS further out. Valuation, however, rises, largely due to a higher rate base in the US than we previously forecast, and continued sterling weakness. We increase our target price by 50p to 1,030p, and with a c15% 12-month potential total return, we reiterate our Buy rating. Next week’s announcement could spark some volatility, but looking through this, we view National Grid as a long-term core holding, and one which is positively exposed to governmental support for infrastructure build, and the road to net zero.
Near term results impacted by Covid-19 National Grid reported a +1% YoY rise in underlying EBIT in FY19/20, -3% below expectations, driven by a GBP117m US bad debt provision related to Covid-19. Similar impacts are expected in FY20/21e, as well as incremental Covid-19 related costs which, together with tariff increase delays imposed on New York networks, point to a GBP400m PandL hit this year from the pandemic. Cash outflow could reach up to GBP1bn, taking into account the effects of lower demand as well as measures undertaken to protect vulnerable customers. Structural value creation outlook intact, fuelled by the US Regulatory true-up mechanisms and future rate filings should help recover the Covid-19 related shortfalls, the majority over the next 2-3 years. We cut our FY20/21e underlying EPS by -15% but our medium term (FY23e) forecasts are unchanged, with catch-up upside. National Grid''s solid capex plan should sustain total RAB growth of c.6% pa, fuelled by the US (+7-8% pa). The latter should contribute about twice as much as the UK networks to group EBIT in the years ahead. National Grid''s 9% achieved RoE in the US well exceeds that of any network of peers in Europe. Reassuring comments on dividends - we expect no cut from the UK regulatory review National Grid''s CEO stressed the board''s confidence in the dividend policy, which grows with inflation (we expect indexation to switch from RPI to CPI next year, in line with UK RAB indexation under RIIO-2), assuming a reasonable regulatory outcome. We continue to see National Grid as being able to create substantial value under RIIO-2 (see NATIONAL GRID: Mispriced value creation) and see DPS payout quickly receding from a near term 90% level to a sustainable 70-80% range. Reiterate Outperform rating We see no structural effects from Covid-19, and in fact slightly up our valuation (fine-tuning US premium and long-term UK incentives). The Grid''s 24% EV premium to group RAB is aligned with...
Below market expectations, but in line with our estimates. Operating profit was flat compared to last year and came in at £3,454m (consensus was £3,590m, our estimate was £3,442m). EPS decreased by 1.5% to 58.2p (consensus was 59p, our estimate was 58.1p). Dividend increased by 2.6% to 48.57p (consensus was 48.7p, our estimate was 48.8p). The group estimates the impact on operating income to be in the region of £400m, but recoverable over future years.
Underlying operating profit hit by bad debts in US NG has reported underlying operating profit of £3,454m (INVe £3,514m, consensus £3,568m), underlying EPS of 58.2p (INVe 58.2p, consensus 59.4p), and DPS of 48.57p (INVe 48.76p , consensus 48.75p). Net debt was £28.6bn (INVe £28.1bn, consensus £28.7bn). Covid-19 has hit the US business with a £117m bad debt charge, above the $100m we had assumed, and it is the US business that accounts for the shortfall vs. our estimates, as the both UKET and UKGT were slightly ahead. c£400m Covid-19 impact in FY21, recovery timing uncertain Covid-19 is set to impact FY21 to a greater extent, with NG pointing to an underlying profit impact of c£400m. NG expects to see some additional costs in the UK and a limited impact in its NGV business, but most of the impact will come from its US business, driven by three, broadly similar, impacts: (i) the deferral of rate increases, (ii) Covid-19 related costs, and (iii) higher bad debt charges. NG estimates that the latter will be slightly bigger in FY21. Technical guidance for the US points to a >£100m yoy revenue increase, below our c£300m movement, due to a deferral of upstate NY rate increases, and delays in rate increases at KEDNY/KEDLI. Additional costs are put at >£150m, and together we expect this to see downwards pressure on consensus for FY21. NG expects to recover a large part of this, but this will be subject to regulatory discussions, with no clarity on timing, or guarantee of success. £1bn Covid-19 cash flow impact There will also be impacts in the UK, but with regulatory mechanisms in place, the majority will be treated as timing differences, and not form part of underlying calculations. However, they will impact cash flow, and NG is suggesting an impact across the group of up to £1bn, with net debt is expected to rise by c£3bn on a constant currency basis from the FY20 reported £28.6bn. Ex currency, we have a £2.5bn outflow in FY21E, suggesting that we, and consensus, need to move to higher debt levels.
A housekeeping exercise on estimates sees minor changes to EPS (Figure 1), positioning us slightly above consensus in the near-term, and more so in FY22E and FY23E. No change to our RIIO-2 cost of equity assumption which remains at 4.8% CPIH real, but we have increased assumed RIIO-2 annual totex allowances to £1.33bn (2020/21 money, from £1.2bn) for NGET and £458m (2020/21 money from £300m) for NGGT, representing 90% and 80% of business plan submissions respectively. The lower % applied to gas reflects uncertainties around the future of gas. We continue to assume that RIIO-2 commences in April 2021, although it is possible that Covid-19 impacts the open hearings. KEDNY and KEDLI rate cases in the US are ongoing, and we have lowered our assumed allowed ROE to 8.7%, previously 9%. This is a discount to the filed request for 9.65%, the level of discount consistent with that in the approved joint proposals in the recent ConEd New York electric and gas rate cases. Regulatory structures offer volume protection, but there is a potential risk of increased bad debts in the US given a 7.1m retail customer base, which would have cash flow implications, with no clarity on how regulators would respond. Our target price is nudged up to 990p, with higher NGET (34% FY21E RCV premium) and NGGT (34% FY21E RCV premium) values partially offset by higher pension liabilities. Pension liabilities could see upwards pressure from lower discount rates vs. September, with the US more at risk. Downwards pressure on asset values is also likely given equity exposure. A 20% decline in the quoted equity value component of pension assets vs. March 2019, and a lowering of the US discount rate by 20bps would trim c33p from our SOTP.
Ofgem has published the results of the 2019 Annual Iteration Process… Ofgem just published the results of the 2019 Annual Iteration Process (AIP) for the energy network companies under the RIIO framework. The AIP recalculates base revenues across the four price controls (electricity distribution, gas distribution, electricity transmission, and gas transmission), and compares these to what was initially allowed at the outset of the regulatory period. The difference is known as the MOD, and is factored into revenues for the next regulatory year (2020/21). …impact across the entire network space is a c.£1bn revenue adjustment in 2020/21 This year’s AIP has reduced the allowed revenue that network companies will collect relative to the assumptions made at the start of the price controls by around £965m in 2018/19 prices, with the reduction driven by lower interest rates compared to the level set at the start of the price controls, and network companies spending less totex than the amounts assumed at the start of the price controls. National Grid’s MODs electricity and gas in line with our expectations – immaterial earnings impact We explicitly forecast the MOD for National Grid’s electricity transmission (NGET) and gas transmission (NGGT) businesses in our modelling. Ofgem has calculated the NGET MOD at £(382)m and the NGGT MOD at £(65)m, compared to our estimates of £(368)m and £(65)m respectively, all in 2009/10 prices. The aggregate £14m impact is immaterial in the context of National Grid’s earnings, at c.0.7% of our FY21E forecast at the net income line when adjusted for inflation.
Solid H1 19/20, backed by the good progression in the UK and a slight increase in the UK Electricity Transmission division. After the promising investments, the group is well on track to meet its asset growth guidance of 5-7%. Positive view confirmed.
Underlying EBIT in line, tax drives EPS beat Underlying EBIT of £1,301m in line with Investec (£1,285m) and consensus (£1,275m), albeit with the US beating and the UK coming up a little short. The US beat appears to be a consequence of income expected in 2H being received in 1H. EPS of 20p betters our 15.9p estimate and consensus of 17.6p due to the US beat, and in a £48m tax settlement in the US in respect of prior years. The interim dividend of 16.57p is in line with Investec/consensus/guidance. National Grid (NG) guides to a £1bn increase in net debt in 2H from the £27.8bn reported at 1H20, albeit this is based on the end-September FX rate of £1 = U$$ 1.23. Our FY20E net debt of £28bn would rise to £28.3bn based on September FX rates, suggesting that our net debt estimate is slightly more optimistic than NG’s guidance. Divisional technical guidance unchanged, NG on track Although the granularity of expected FY outperformance in UK Electricity Transmission has changed, there is no change in the overall level of outperformance expected from this division. Technical guidance for the other divisions remains the same. Below the line, the effective tax rate is expected to be 20% vs. the previously communicated 20%. At a consolidated level, our initial view on numbers is that NG is on track. Broader issues driven by legitimacy challenge As we have previously discussed, wider issues for NG, which we expect to be discussed at this morning’s presentation include the dispute with the NY State Governor, the KEDNY/KEDLI rate cases, the RIIO-2 process where NG’s 6.5% CPI-real cost of equity ask is markedly higher than Ofgem’s current evidenced-based position, and the ramifications of the 9th August power cut in the UK. See table overleaf
Electricity transmission – we expect a similar 1H/2H split of underlying EBIT to FY19A, and view our estimate of £611m as supportive of 9.7% FY growth driven by higher regulatory revenues and cost reduction. Gas transmission – 1H is likely to be impacted by billing related to Avonmouth revenues, and while we look for FY growth of 12.8% in underlying EBIT, our 1H estimates suggest a flat outturn in this period. US regulated – we see the US as National Grid’s strongest growth business, and with no expectation of a meaningful shift in the 1H/2H split, we expect this to be the case in 1H too. Cost reduction, revenue growth and sterling weakness are all set to contribute. NGV & Other – we expect property sales to decline, with profit accruing evenly over the year, our £90m being 50% of our FY estimate for underlying EBIT. We look for net debt of £27.5bn, slightly below our FY estimate of £28bn, and expect National Grid to retain the 34/66 interim/final dividend split, with our estimate for the interim dividend at 16.58p. Issues we expect to be discussed on the call (9.15am, +44 20 3003 2666, password National Grid) include the business plan submissions for RIIO-2 and requested cost of equity, the 9th August power cut in the UK, rate case progress at KEDLI and KEDNY, the dispute with the NY State Governor, and the impact of Capacity Market reform on interconnector revenues.
In a change of view, Ofgem has announced that it is now minded to use the RIIO regulatory framework to fund National Grid’s investment in the Hinkley-Seabank (HSB) transmission link, having previously taken a decision to use the Competition Proxy Model (CPM). Updated analysis suggests that the benefits of using CPM for HSB are now unclear. Given National Grid’s vehement opposition to the CPM, a view shared by the Scottish transmission operators, we consider this to be a major victory of principle for National Grid, and a positive for the stock. Ofgem has indicated that CPM remains a tool in the toolbox, but we question its future. Indeed for National Grid, it is highly likely that none of its projects will now be delivered under the CPM. Ofgem is minded to allow capital costs of £637m for HSB vs. a submission of £716.8m. However, National Grid has previously pointed to a total cost of around £650m, and Ofgem has held out the possibility of additional funding should certain high impact, low probability risks occur during construction. The cost differences are likely to be considerably smaller than those used by Ofgem in its press release.
Earnings tweaked – We have undertaken a housekeeping exercise on our National Grid estimates that sees EPS nudge up slightly by 1-2% across FY20E-FY23E. The movement is a consequence of the impact of a 1.25 year-end $/£ exchange rate assumption (vs. 1.31 previously) on the contribution from the US business and higher JV income, offset by a lower contribution from the property business in National Grid Ventures, and a higher share count given the scrip dividend take-up. Valuation moved up by 4.5% – Although our view of National Grid’s fundamentals remains unchanged, our valuation moves up by 4.5% to 971p (from 929p), a consequence of the earnings revision, and from rolling our valuation point forward a year to FY21E. This aligns our approach to the one we take in our valuation of the UK water stocks (see sector note published today). Nationalisation discount removed, target price 970p, Buy – Hitherto, we have applied a discount to our National Grid valuation, rebasing UK regulated activities to RAB to set our target price. In our analysis of the UK water sector, we argue that Jeremy Corbyn’s chances of taking up residence in 10 Downing Street are reduced, suggesting the risk of nationalisation of regulated utilities is lower than when we initiated coverage of National Grid in June. We have removed the discount, and set our target price at 970p. Pointing to an implied 17% 12-month return, we upgrade to Buy.
Massachusetts Electric awarded ROE of 9.6% The Massachusetts Department of Public Utilities (DPU) has issued its rate case order for Massachusetts Electric. The order approves a five-year rate plan with new rates effective 1 October 2019. The allowed ROE is 9.6%, with an equity ratio of 53.5% and a revenue increase of $38 million. The order includes a new Performance Based Rate Mechanism (PBRM) that will fund both capital and operational expenditure across the duration of the rate plan, ensuring inflation is factored into the cost base. Massachusetts Electric’s filing was for a 10.5% ROE, an equity component of 53.49%, a five year plan, and an additional $70m revenue requirement, subsequently amended to $55m. Proposals for storage and EV charging welcomed, but deferred to a future filing Massachusetts Electric also made proposals for investment in energy storage ($50m) and electric vehicle charging infrastructure ($167m). The DPU remains supportive of these investments to modernise the grid, and have recommended resubmission of these requests as part of a future filing. Negligible impact of lower return, five-year visibility a positive We are not surprised that the case has been settled below Massachusetts Electric’s filing given that the process is essentially one of negotiation. The previous ROE for Massachusetts Electric was 9.9% with a 51% equity ratio, and with Massachusetts Electric representing c.11% of the US rate base, the impact of the lower return is negligible, with the five-year settlement providing visibility.
Kwasi Kwarteng questions whether National Grid should retain its ESO role The FT website has reported, with additional coverage in The Times, that Kwasi Kwarteng (UK Energy Minister) has questioned whether National Grid should retain its Electricity System Operator (ESO) role. The ESO has been a legally separate entity within Grid since 1 April of this year, and National Grid was also required to take a number of physical measures (walls, separate entrance, etc.). At the time that Ofgem consulted on the separation in 2017, it invited views on greater separation, with some respondents calling for harder separation. Ofgem will be reviewing the effectiveness of the current level of separation in 20/21. Ofgem to release its investigation into August’s power cut around end October National Grid submitted its final report into the power outages of Friday 9 August last Friday, and we expect that Ofgem will make this public tomorrow around 10am. However, we see the results of Ofgem’s investigation into the power cut as being more important, and it is possible that when Ofgem publishes this (expected end October), the possibility of the ESO being transferred outside the Grid group could be raised. Highlights that political/regulatory risk likely to remain irrespective of who inhabits No. 10 The ESO is a small part of the group in financial terms, and if a move saw the ESO become a public body, it could be a partial counter to Labour’s nationalisation proposals. It could also reduce the risk of reputational damage in the future. Unsurprisingly, National Grid remains opposed to the idea of an independent system operator in the UK, although in part such a stance could be seen as seeking to maintain a strong negotiating hand in the event. However, comments such as these by Kwasi Kwarteng underline that political and regulatory risk is likely to remain, irrespective of the inhabitant of No. 10.
The lights go out in the UK… The major power cut that hit the UK on Friday evening has provoked a significant backlash, with Ofgem calling for an urgent detailed report from National Grid, and the government commissioning its Energy Emergencies Executive Committee to consider the incident. National Grid ESO has made it clear that the root cause of the issue was not with its system, and was a rare and unusual event caused by the almost simultaneous loss of two large generators at 16:54, RWE’s Little Barford CCGT, and Orsted’s Hornsea One offshore wind farm. The usual response to the loss of generation capacity is for capacity held in reserve to increase output, and the ESO has indicated this was the case, albeit the loss of generation was so significant that a backup system was triggered which disconnected selected demand across GB. All demand was reconnected by 17:40. …but who is to blame? A blame game has been played to a degree with distribution companies quick to point the finger at National Grid, and National Grid claiming the root cause was not with its system. There are many questions that need answering by the various post mortems that will be taking place, including whether more fast response capacity should be in place going forward, whether consumers would be willing to pay for this, the hierarchy of demand disconnection, and given the disruption to transport, the ability of the rail industry to respond to operational issues like this. Never mind the possibility of a fine, legitimacy and political scrutiny are the issues Ofgem’s enforcement process allow for fines of up to 10% of the regulated person’s turnover. This would either be NGET’s turnover (£3.35bn in 18/19), or that of the ESO, a smaller number. However, it is too early to speculate on fines, and even if National Grid is found to be at fault and Ofgem plays tough, a fine of £335m only represents 1% of market cap. Of more importance is the likely increase in regulatory and political scrutiny, and the questions of network resilience this will bring. Recent opinion polls suggest Jeremy Corbyn’s chances of getting the keys to 10 Downing Street are on the wane, and with it nationalisation withering on the vine, but we have repeatedly suggested that legitimacy is all important. Friday’s event bring this into sharp focus, and in the short-term this is unlikely to be helpful for network utilities. Longer-term, the outcome might well see increased funding for network resilience, a possible benefit, while those who offer back-up generation and storage solutions might well see increased demand for their services.
National Grid (NG) has published executive summaries of the draft RIIO-2 business plan for both National Grid Electricity Transmission (NGET) and National Grid Gas Transmission (NGGT). Both envisage a significant step-up in annual baseline totex versus RIIO-1, and both are based on financial parameters significantly higher than Ofgem’s working assumptions. Once again, legitimacy will be in the spotlight, and given Ofgem’s hitherto firm stance on allowed returns, we expect that changes will need to be made in the next iteration of the plans. Adjusting our estimates to reflect NG’s baseline totex would add c.40p to our unadjusted equity valuation, equivalent to a 4% uplift. NGET draft business plan envisages £1.5bn annual baseline totex NGET’s draft business plan envisages average annual baseline RIIO-2 totex of £1.5bn in 2018/19 prices vs £1.2bn in RIIO-1. Asset spend to ensure reliability, increasing protection against cyber attacks, and visual impact projects are key drivers of the increased spend. NGET estimates that its part of the average household bill will be £23.50 (2018/19 prices) in RIIO-2, of which the draft plan accounts for 20%. NGET’s baseline totex is c.30% above the £1.2bn we have assumed in our estimates. NGGT draft business plan envisages £0.6bn annual baseline totex NGGT’s draft business plan envisages average annual baseline RIIO-2 totex of £0.6bn in 2018/19 prices vs £0.4bn in RIIO-1. c.60% of NGGT’s totex plan for RIIO-2 relates to three areas of investment: asset spend to ensure reliability; increasing protection against cyber and physical security attacks; and expenditure to meet emissions legislation compliance by 2030. NGGT estimates that its part of the average household bill will be £10 (2018/19 prices) in RIIO-2. NGGT’s baseline totex is double the £0.3bn we have assumed in our estimates. Push back against Ofgem working assumptions – NG proposes cost of equity of 5.5% real Both plans assume a base cost of equity of 5.5% in RPI real terms, in line with National Grid’s response to Ofgem’s December 2018 RIIO-2 framework consultation, and with NG reiterating its concerns about Ofgem’s proposals. However, like SSE, NG’s proposal is significantly higher than Ofgem’s working assumption of an allowed return of 4.3% CPIH real. NG’s cost of debt assumption of 1.74% RPI real is also higher than Ofgem’s working assumption of 1.93% CPIH real. Consequently, NG’s plans are based on a rate of return of 3.2% RPI real vs Ofgem’s working assumption of 2.88% CPIH real. Given the firmness of stance from Ofgem, we expect that updated draft business plans in October will need to reflect a lower cost of equity than that currently built in. Our estimates assume no outperformance wedge, and an allowed return of 4.8% CPIH real.
National Grid released a good set of FY18/19 results. Activities in the US continue to lead the RAV growth and the group continues to invest in the UK to increase the quality of its network. But this good publication was spoiled by Labour’s suggestion to nationalise the energy networks. Although this seems unlikely, it will be a driver of the stock price in the short term.
National Grid released a set of H1 results which were broadly in line with our expectations. The underlying operating profit fell 6% but NG was able to post 6% growth in underlying EPS – broadly in line with our estimates – as the tax rate declined to 19.3% from 22.9% (US-driven) while the Electricity Transmission business in the UK performed well. The group confirmed its dividend policy. We stick to our Buy recommendation.
National Grid reported a good set of FY17-18 results, driven by the US activities, which posted a +20% increase in underlying operating profit fuelled by the 7% rate base growth and favourable rates renewals during the period. The board proposed a FY dividend of 45.93p, up c.3.7%, in line with RPI. The company provided a reassuring outlook and expects growth at the top end of the guided 5-7% range for the medium term, driven notably by the US market.
The company has reported weak H1 results with reported profit down 12.7% to £1.27bn, but up 4% to £1.4bn on an adjusted basis for one-offs and timing effects. The group has reported EPS down 11.75% to 19.5p/share and -13.2% on an adjusted basis. Despite this, and in line with its dividend policy to pay a dividend growth linked to inflation, the group will pay an interim dividend of 15.5p/share which represents 2.1% growth. The group maintains, nonetheless, its full-year outlook as it expects to see a recovery in H2 due to seasonal effects, especially in the US. Moreover, concerning the nationalisation debate, as re-nationalisation was included in Labour’s manifesto last month, National Grid responded that electricity transmission costs today are 30% below pre-privatisation levels and that £14bn had been invested in infrastructure in the last 10 years.
The group has published positive full-year results with adjusted operating profit increasing by 14% to £4,667m, profit before tax increasing 13% to £3,555m and EPS growing 16% to 73p. These are all better than expected. The strong yearly performance was mainly driven by the US (+45%), UK electricity transmission (+17%) and gas transmission (+5%). Gas distribution was up 2%. Net debt reached £19.6bn (-19.7%). On a reported basis, the group published operating profit increasing by 0.5% to £4,102m and EPS increasing by 201% to 207p as it takes into account the £5.32bn gain from the disposal of the UK gas distribution business, out of which £4bn will be returned to shareholders. The group has proposed a dividend payment of 44.27p, representing a 2.1% increase, in line with expectations. For 2017/18, the company expects to have a further improvement in the US from positive tariff revisions in NY and Massachusetts. Although it expects the UK transmission business to be slightly down, driven by an expected lower incentive performance.
National Grid’s high visibility revenues, underwritten by regulatory returns across the UK and US, offer equity holders an attractive combination of asset growth and a 4.3% dividend yield. Both the UK and US businesses are well run. The UK business has predictability of revenues until the end of the current regulatory period in 2021 and is delivering returns ahead of OFGEM’s expected ‘base returns’. In the US, a rate filing programme is underway, which will result in enhanced returns in the years ahead. Now that the sale of the UK Gas Distribution is complete, management can continue to focus on delivering shareholder returns across its business units. Management targets 5-7% asset growth, and our fair value per share of 1,120p offers 11.2% upside versus current prices.
National Grid’s high visibility revenues, underwritten by regulatory returns across the UK and US, offer equity holders an attractive combination of asset growth and a 4.3% dividend yield. Both the UK and US businesses are well run. The UK business has predictability of revenues until the end of the current regulatory period in 2021 and is delivering returns ahead of OFGEM’s expected ‘base returns’. In the US, a rate filing programme is underway, which will result in enhanced returns in the years ahead. Now that the sale of the UK Gas Distribution is complete, management can continue to focus on delivering shareholder returns across its business units. Management targets 5-7% asset growth, and our fair value per ADR of $69.40 offers 9.1% upside versus current prices.
National Grid has agreed to sell a 61% stake in its UK gas distribution business to a group of infrastructure investors called Quad Gas (Macquarie Infrastructure, Allianz Capital, Hermes IM, CIC Capital, Qatar Investment Authority, Dalmore Capital, and Amber Infrastructure). The agreement assumes a business valuation of £13.8bn including debt. The transaction is expected to be completed by Q1 17. National Grid should receive a cash payment of £3.6bn in addition to £1.8bn from debt financing, bringing the total to £5.4bn. As part of the deal, National Grid expects to return around £4bn to shareholders, of which 75% (£3bn) is expected to be given back as an exceptional dividend in Q2 17. National Grid and the consortium Quad Gas have also expressed an interest in the possibility of a further transaction to take an additional 14% stake in the gas distribution company, with broadly equivalent financial terms to the current transaction’s. Given that the transaction can be classified as a class 2 for the UK financial Authority, it does not require National Grid shareholders’ approval, it just needs the clearance from the European Commission.
National Grid (NG) reported interim (H117) results on Thursday showing performance in line with guidance and maintaining its outlook. As expected, the UK Gas Distribution disposal is on track to complete early next year. Operationally, management continues to focus its energy on filing rate cases in the US with good progress achieved in Massachusetts Electric and KEDNY/KEDLI. In the UK, the company continues to negotiate with the regulator in the future of its role as system operator. RAV growth, capex and interim numbers were all in line with guidance. We reaffirm our fair value range of $55-69/ADR.
The company has reported relatively stable half-year results, but these are slightly below our expectations. Operating profit reached £1.9bn, helped by timing and FX, with the adjusted operating profit still reaching a 1% yoy increase to £1,851m, while adjusted EPS remained near the previous year’s level at 28.2p. On a reported basis, on the other hand, the group had £718m of debt redemption costs linked to the sale of the gas distribution business for which the group had to re-purchase £1.9bn in bonds with a £1.8bn nominal value and a £2.9m market value. The cash loss (£0.9bn) has been offset by £0.2bn of gains on hedges and additional tax credits, which reduced the exceptional effects to -£558m and pushed downwards the net income of the company to a 51.8% yoy decrease in net profit to reach £504m, which represents an EPS of 13.4p. Capex increased 12% yoy (6% at constant FX). Profits were negatively impacted by a sharp decrease in the property and international connector divisions (-45% yoy), as the performance achieved in 2015 was not expected to be repeated, but it was more than compensated by the strong performance in US-regulated activities (+12% yoy). An interim dividend of 15.7p/share will be paid, which is in line with expectations and policy (growth in line with inflation). The scrip option is maintained. Guidance for the full year has been confirmed.
Asset-base growth and shareholder returns remain the two lynchpins of National Grid’s equity story. The investor teach-in may have focused on National Grid’s ‘other’ businesses segment, but we update our forecasts for the whole group and find the mixture of growth, returns and optionality attractive. Additional value from the disposal of National Grid’s UK gas distribution business offers upside to our fair value range of $55-69/ADR (800p-1,050p).
An energy committee of UK lawmakers (the UK’s Energy & climate change committee) have published a report recommending that National Grid should no longer operate the country’s energy network and that it should be transferred to an independent system operator (following the model already applied in USA). The government has 60 days to respond to the recommendations proposed by the committee. Moreover, the MP’s are demanding that National Grid be separated from its interconnector assets as this may create a conflict of interest for the company in terms of priority usage ahead of local generators to balance electricity demand and supply. In November 2015 Amber Rudd, the UK’s Secretary of State for Energy, stated that the national regulator Ofgem should reconsider National Grid’s role to be more independent, but it has been the system operator for the last 26 years. National Grid currently holds interconnection assets with France and the Netherlands, Norway is under construction and there are plans to expand to Belgium and Denmark.
Strong FY results for the company with the operating profit increasing by 8% yoy to £4.08bn and 6% yoy on an adjusted basis, which is in line with estimates. Moreover, profits before tax are up 15% yoy to £3.03bn and 9% on an adjusted basis, which is ahead of forecasts. Following the same positive path, reported EPS reached 69p which is a 30% yoy increase and a 10% increase on an adjusted basis to 63.5p, beating consensus. However, the dividend is slightly below expectations despite the 1.1% yoy increase at 43.34p, with net debt increasing more than expected to reach £25.3bn, a 5.8% yoy increase. The divestment of the majority stake in the gas distribution business is expected to be achieved in early 2017. The company expects a performance broadly in line with the level seen last year.
Aside from H1 results that demonstrated strong operational execution in the UK and reiteration of US rate filing prospects, National Grid has announced the intended sale of a majority stake in its UK gas business. The prospect of shareholder returns and long-term stronger growth outlook from the deal underpins the attraction of the company’s combination of growth and yield. Our new valuation range is 874-1,067p per share ($66.5-81.2/ADR).
Positive half-year results for the group, revenues increased by 7% to £6.85bn. The increase wasdriven by growth in all operating segments, with UK electricity transmission increasing by 10%, gas transmission by 16%, gas distribution by 2.5%, US regulated activities by 6.3% and other activities by 13%. Therefore, operating profit increased by 14% to £1.84bn, beating expectations by 6.8%. Financial expenses remained within the previous year's level, which boosted net income by 15% to £1.05bn, translating into a 28.4p EPS. An interim dividend payment of 15p per share has been proposed. Operating cash flow remains strong with a 4% increase reaching £2.52bn, enough to offset the 36% increase in investments to £1.9bn, while it maintains free cash flow in positive territory. Net debt reached £24.6bn, increasing by 3%, helped by a stronger US dollar as, excluding the forex impact, net debt increased by £950m (4.1%).
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