Recently I've reviewed several U.S. and foreign utilities searching for good income opportunities. So far, the best value was found on electricity and gas network operators, which enjoy very high profitability and good growth prospects, like Enagas (OTC:ENGGY) or Terna (OTC:TEZNY). However, for U.S. investors this meant being exposed to companies which operate mainly domestically, in countries like Spain or Italy. Nevertheless, investors can also benefit from the stability of network operators in the U.S. through National Grid (NGG), which is based in the U.K. but is also exposed to the U.S. electricity market.
National Grid is an international electricity and gas company and one of the largest investor-owned energy companies in the world. It is a portfolio of distinct regulated businesses in the U.K. and the U.S., and some unregulated businesses primarily in the United Kingdom. National Grid has a market capitalization of about $42 billion, and is traded in the New York Stock Exchange.
The company owns and operates the electricity transmission network in England and Wales, the gas transmission network in Great Britain, and electricity transmission networks in the northeastern U.S., where it owns and operates an electricity transmission network of approximately 8,700 miles spanning upstate New York, Massachusetts, Rhode Island, New Hampshire, and Vermont. National Grid also owns and operates the gas distribution systems in the U.K. and northeastern U.S. Its non-regulated businesses are principally metering services, property management, liquefied natural gas [LNG] storage, LNG road transportation, beyond others. In the U.S. National Grid owns and operates 50 fossil fuel powered stations on Long Island and 4.6 megawatts [MW] of solar generation in Massachusetts. It does not have any electricity generation business in the U.K. In the U.S., it also owns distribution networks serving around 3.4 million customers. National Grid generates about one-third of its operating profit in the United States.
Regarding National Grid's financial performance, it has achieved good results over the last few years. In its last financial year 2012/13, which ends in March, its revenue was above $23 billion, a decrease of 3.5% from the previous year. National Grid's EBITDA was above $7.3 billion, or an EBITDA margin of 34.4%. Its adjusted operating earnings increased 4% to a record high of $5.6 billion. The group's return on equity [ROE] was 11.2%, an increase from the previous year but penalized by the impact of major storms in the U.S. Its earnings per share was up 12% to $8.70.
One of the main positive factors about National Grid is its heavily regulated business, providing a stable business environment for the company. Moreover, a few months ago National Grid reached an agreement with the U.K. regulator accepting new price controls, which give 8 years of price clarity. Going forward, National Grid should be able to achieve low-single digit growth among the majority of its businesses, and if the company increases its efficiency it may also improve its profitability. For instance, in the U.S. National Grid has successfully obtained rate reviews in all the underperforming businesses, which should allow the company to meet its overall target of a 10% ROE in North America.
National Grid's dividend history is quite good over the past five years, at least when measured in dollars. The dividend was always raised except in 2011, when it was stable compared to the previous year. However, when measured in British pounds the company did cut its dividend in 2011 by 5.5%. National Grid pays two dividends during the year. An interim dividend is usually paid in January, and a final dividend in August. Its last dividend was $3.16 per share, an increase of 1.6% from the previous annual dividend. National Grid has also a scrip option, where new shares are issued for shareholders instead of a cash payment. In the last four years, the company has saved almost $2 billion via the scrip option, which also helped to reduce leverage.
Following its regulatory review in the U.K. coupled with the rate plans agreed to in New York, and Rhode Island, National Grid reviewed its dividend policy at the beginning of the year. Since April, 2013, the company's new dividend policy is to grow the dividend at least in line with the United Kingdom's retail prices index [RPI] measure of inflation each year for the foreseeable future. National Grid aims to continue to deliver an attractive, growing dividend while maintaining a strong balance sheet over the coming years. Over the long term, it is reasonable to expect an annual inflation rate of about 2% to 3%, which should set a floor for the company's annual dividend growth. Therefore, the biggest risk to National Grid's dividend is if inflation starts to fall.
On the negative side, like most of its peers National Grid's indebtedness is relatively high. At the end of its fiscal year 2012, the company's net debt was above $33.2 billion, an increase of more than 9% during the year. This represents a net-debt-to-EBITDA ratio of 4.5x, which is relatively high even taking into consideration the company's low-risk business and good profitability. The company expects debt to increase at the same level of EBITDA over the next few years, sot its balance sheet leverage should remain stable at about 4-4.5x EBITDA.
National Grid is attractive due to its regulatory certainty and high-dividend yield of 5.5%. This stable operating environment has allowed National Grid to commit to a new dividend policy, which should provide income investors with a safe income stream for the next few years. Even tough National Grid's growth should be low for the foreseeable future, the downside risk seems limited and National Grid therefore is a reliable dividend payer over the next few years.