National Grid (NYSE: NGG) is a bit unusual in the utility sector, with dividend yields as high as 5.5%. A quick look at power and gas companies may give investors a positive view of the company.
However, some recent corporate changes and political issues in the UK have brought a bigger problem, which may get investors' attention, but still cause major problems. Before investing here, you need to know the following.
On the surface, National Grid is a boring utility that can provide customers with electricity and natural gas. Over time, it has achieved good results, including investing in its assets to maintain high reliability and expanding its business in due course. For example, in the first half of fiscal 2019, the company spent £ 2.7 billion on capital investments. Its target is to spend about £ 5 billion in fiscal 2019, up from about £ 3.3 billion in 2015.
Capital expenditures are a good thing for utility companies like State Grid, which mainly owns controlled assets. In essence, in exchange for a monopoly on its services sector, the company must get a rate hike approved by regulators. These decisions involve many factors, but some of the important ones are reliability and investment planning. Therefore, over time, State Grid's spending will likely help it get approval for higher interest rates.
That said, State Grid talks about its investment in pounds. This is because it is headquartered in the UK and about half of the company's operating profit comes from electricity and gas assets. About 40% of the company's operating profit comes from the US market, and it also operates power and natural gas assets. The remaining operating profit comes from "other" companies. All in all, this is not your usual tool, it is more diverse than before.
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general, diversification is a net gain for investors, as poor performance in one business area can be offset by good performance in another. But the fact is: according to the utility standards, State Grid's 5.5% dividend yield is very high. For reference, Vanguard Utilities ETF, an agent in the utility sector, has about 3% of revenue. So there are other things here. One fact is that the multi-country risk of State Grid adds complexity, but that's not all.
Britain has been working to nationalize major industries, including the utility sector. The left-leaning Labour Party is pushing this effort under Jeremy Corbin. Nationalization will soon destroy about half of the State Grid business. However, due to weak elections in late 2019, Corbin announced his intention to resign as Labour leader. Assuming nationalization is a dead issue, investors see it as good news and quickly nationalize it.
The problem with this logic is that nationalization is an uncertain political process, and winds often change in rapid and unexpected ways. In fact, Corbyn's resignation may not eliminate the threat. It is worth noting that he will remain in Congress and has the potential to become an important voice for Labour. In addition, as the issue of COVID-19 spreads across the globe, the likelihood of a global decline seems to be increasing. If the UK economy is in recession, calls for government action to help the British public may increase instead of decrease. This can easily make the problem of nationalization last longer.
To its credit, State Grid has been taking steps to mitigate any potential damage. At the end of 2019, it created companies in countries that have signed bilateral trade treaties with the UK to "own" the underlying assets. This increases shareholder protection but does not eliminate the political threat posed here. The company took this step, proving that the threat is real, and it's hard to believe that a single election could eliminate the problem. Also note that the impact of privatization on shareholders can be huge, as any effort by the UK government to take over utility assets will include competing for the value of those assets (the government is unlikely to make a generous offer). Perhaps worse, the ideas surrounding payments include investors getting government bonds, which is
In general, it is too early to say that the resistance to privatization of the State Grid has completely disappeared. With architect Corbyn still serving in the UK government, panic coronaviruses and the global recession could easily make privatization a reality again. To be fair, the political threat here may also be history, but this only highlights the real problem: it is difficult to determine at this point. This is the uncertainty that other utility options do not have to face.
During these uncertain times, for most investors, the additional risks faced by State Grid today are not worth it. There are other high-yield options, and headline risk is greatly reduced.
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News Reference: https://www.nasdaq.com/articles/is-national-grid-stock-a-buy-2020-03-21