Morning Note: Market news and good results from National Grid

Thursday 18th May 2023

Market News?

Equity markets are moving higher on optimism over the debt-ceiling talks. Gains in the US last night – S&P 500 (+1.2%); Nasdaq (+1.3%) – were matched in Asia this morning: Nikkei 225 (+1.6%); Hang Seng (+0.8%); Shanghai Composite (+0.4%). The FTSE 100 is currently trading 0.4% higher at 7,761. Stocks trading ex-dividend today include GSK (0.97%), Shell (0.96%), Unilever (0.88%), Bunzl (1.44%), and Vonovia (4.6%).

Getting a debt-limit deal done this week is “doable,” House Speaker Kevin McCarthy said after he sat in for staff-level talks last night. Joe Biden also expressed confidence on reaching a deal. Jamie Dimon echoed that sentiment after he and other top bank executives met with Senate Majority Leader Chuck Schumer on the issue.

Treasuries climbed – the 10-year currently yields 3.56% – and the dollar was steady. Gold drifted back to $1,978 an ounce. Sterling buys $1.2462 and €1.1514. Brent Crude trades at $76.50 a barrel, after rising by almost 3% yesterday. The US is resorting to rare purchases of European wheat after a drought upended crop markets.

US commercial real estate prices fell in Q1 – the first retreat since 2011 – and “lots more” declines are coming, Moody’s said. It added that the magnitude of a potential correction may be sizable and may lead to credit losses at banks. The less-than-1% decline so far was led by drops in multifamily residences and office buildings.

The euro’s use in international payments dropped in April to the lowest in three years as those using the US dollar ticked up and the Chinese yuan's share rose to the highest in five months, according to SWIFT. The proportion of cross-border transactions involving Europe's common currency fell to 31.74% of the total from 32.64% in March. Dollar usage climbed further to 42.71%.

Company News - National Grid

National Grid has today released results for the financial year to 31 March 2023 and declared a dividend increase in line with the rate of inflation. In response, the shares are little changed in early trading.

National Grid operates a regulated business in the UK and US, with electricity and gas transmission and distribution assets. The group has no direct exposure to volatile commodity prices and relatively little exposure to usage levels.

Over the last couple of years, the group has undertaken several transactions to reposition its portfolio: the purchase Western Power Distribution (the UK’s largest electricity distribution business), the sale of Narragansett Electric Company (NECO) in Rhode Island, and the sale of a 60% stake in National Grid Gas, the owner of the?UK’s national gas transmission system, with an option to sell the remaining 40%. Together these transactions pivot the UK portfolio towards electricity and enhance the group’s role in the decarbonisation of the UK energy system, with investment in infrastructure that enables higher penetration of renewable energy and low carbon technology. Significant investment will be required in preparing the grid for a low-carbon system, while underpinning the company’s asset growth and dividend.

Under its five-year financial framework, National Grid is targeting total cumulative capital investment of up to ￡40bn’ asset growth CAGR of 8%-10% backed by a strong balance sheet’ underlying EPS CAGR at the lower end of 6%-8% (from a FY21 baseline of 54.2p), and credit?metrics to remain within current rating thresholds.

During the latest year, underlying operating profit grew by 10% on a constant currency basis to ￡4.6bn. This reflects a full year contribution from UK Electricity Distribution (formerly WPD), good operational performance across the US regulated businesses, higher contribution from National Grid Ventures (NGV), and increased property sales, partly offset by a shorter period of NECO ownership, and the group’s community support?package.

The group has made good progress (￡236m this year and ￡373m cumulatively) on its cost efficiency programme which is expected to save at least ￡400m p.a. by the end of 2023/24 and deliver a flat controllable cost base even whilst the group’s regulated assets continue to grow.?This enables the group to mitigate some inflationary pressures on both the business and its customers. Underlying EPS grew by 7% to 69.7p, in the middle of the group’s 6%-8% CAGR growth range. The group achieved a Return on Equity of?11.0% in?2022/23, down by 40 basis points.

Capital investment rose by 8% to ￡7.7bn during the year, principally driven by a full year of UK Electricity Distribution ownership, as well as higher levels of investment to drive forward the energy transition and deliver energy security. As a result, asset growth was 11.4%, helped in part by regulatory indexation.

In the UK, National Grid completed the second year of RIIO-T2 price regulation in its UK Electricity Transmission business delivering outperformance in?line with expectations. The group also accepted all the RIIO-ED2 price control arrangements proposed by the regulator Ofgem in its Final Determination, which covers the group’s National Grid Electricity Distribution businesses for the period April 2023 to March 2028. Finally, the regulator has recently awarded the group 17 major transmission projects to enable greater levels of offshore wind connection in the UK.

In the US, the group continued to make good regulatory progress as it aligns its rate filings and agreements with the environmental goals of the states where it operates. The KEDNY-KEDLI businesses filed for new rates in April. Finally, there is $3.8bn of additional longer-term investment for the US business to drive greater connection and delivery of clean power.

National Grid has a robust balance sheet and a strong investment grade credit rating, underpinned by regulatory revenue, which allows the group to secure the required long-term funding needed to invest in its businesses. During the latest year, net debt fell by 4% to ￡41bn, with regulatory gearing of 71%. Now the strategic transactions are complete, regulatory gearing is expected to remain in the low 70% range for the remainder of the five-year period to 2025/26.??????

Adjusted net finance costs for continuing operations were 40% higher than the prior year driven by higher inflation on RPI/CPI-linked debt, new financing requirements to fund the group’s ongoing capital investment programme, and currency movements.

The stock remains popular for investors seeking an attractive income that is growing in real terms. The dividend policy is to deliver annual growth in line with the increase in average UK CPIH inflation. This morning, the group has declared a dividend up 8.77% to 55.44p, covered 1.3x by underlying earnings and equating to a yield of around 4.8%.

Looking to the financial year to 31 March 2024, the group expects underlying EPS to be modestly below FY2023 levels following the UK Government’s change to the capital allowance regime. Without this change, which has a 6p-7p impact, underlying EPS is forecast to grow within the group’s 6%-8% at constant currency. The group’s five-year financial outlook remains unchanged.

The shares have performed well over recent months despite a backdrop of rising bond yields (which make the dividend yield relatively less attractive) and a pick-up in affordability-driven regulatory scrutiny. The market has instead chosen to focus on the benefits of the company’s strategic portfolio repositioning, attractive green credentials, and defensive characteristics.