Monday, July 22, 2024
Home Stock Analysis I like dividends but I avoid National Grid shares – why?

I like dividends but I avoid National Grid shares – why?

by xyonent
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Image source: Getty Images

On the surface, it’s easy to understand why. National Grid (LSE: NG) is a popular choice for many income investors. Firstly, National Grid shares offer a dividend yield of 6.5%, which means that for every £10,000 you invest now, you’ll earn £650 in dividends per year.

This dividend has been increasing every year for many years. For example, over the last three years, the annual dividend per share has increased by 19%, which in my opinion is a significant increase.

A business with little competition and strong demand

But any smart income investor knows you can’t just look at dividend history.

After all, dividends are not guaranteed. sauce Now, about dividends: Given what we know now, how is this company making money, and can it continue to do so in the future?

Again, National Grid shares have some promising characteristics.

After all, energy sources may change, but the need to transport electricity through a power grid will continue for decades to come. National Grid’s existing infrastructure is expensive and difficult, if not impossible, to replicate. Realistically, while companies could try to compete with parts of that infrastructure, no one is going to try.

National Grid is the kind of power monopoly favored by billionaire investor Warren Buffett. In fact, Buffett’s company Berkshire Hathaway The company actually owns Northern Powergrid, a regional electricity grid and supplier focused on the north of England.

So why on earth am I not interested in owning shares in National Grid?

Large debts and large spending requirements

The short answer is debt. And lots of debt.

National Grid started last year with net debt (essentially the liabilities left over after subtracting its assets) of £41 billion. By the end of the year that figure had risen to £43.6 billion.

This is the continuation of a long period of rising net debt: 10 years ago, net debt was £21.2bn, meaning that the company’s already significant net debt has more than doubled in the decade to last year.

Why? Operating and maintaining the power grid is an expensive business that requires significant capital expenditures, and this is likely to remain the case in the future.

The flip side of that spending is that National Grid can run its business and make a profit, but like many regulated utilities, prices are set not just by the market but by governments and regulators.

Why I don’t buy stocks

Do shareholders care? The company has a big dividend payout and National Grid’s share price has risen 15% over the past five years.

But both increasing dividends and increasing net debt can’t continue forever, and one way to reduce debt is to reduce dividend payments and allocate more money to paying down debt.

National Grid did not do that, instead issuing millions of new shares this month as part of a new share issue aimed at raising £7 billion in capital.

This should strengthen the balance sheet for now.

However, while I think it’s sensible, I think it illustrates exactly why I have no interest in holding shares in National Grid – I believe the dividend will be at risk if the company’s net debt continues to rise. A rights issue buys time but doesn’t solve the underlying problem.

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