National Grid — Growth and returns

National Grid — Growth and returns

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.

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Written by

National Grid

Growth and returns

Corporate outlook

Utilities

28 April 2017

ADR research

Price

US$65.05

Market cap

US$49bn

US$1.24/£

Net debt (US$bn) as at September 2016

36.2

ADRs in issue

749.9m

ADR Code

NGG

ADR exchange

NYSE

Underlying exchange

LSE

ADR share price performance

52-week high/low

$56.7

$74.5

Business description

National Grid owns and operates regulated electricity and gas network assets in both the UK and US. Its unregulated assets consist of the Grain LNG import terminal, interconnectors, a metering business and a property business.

Next events

FY17 results

18 May 2017

Analysts

Jamie Aitkenhead

+44 (0)20 3077 5746

Roger Johnston

+44 (0)20 3077 5722

National Grid is a research client of Edison Investment Research Limited

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.

Year end

Revenue (US$m)

PTP
(US$m)

EPADR
($)

DPADR
($)

P/E
(x)

Gross yield
(%)

03/15

19,777

3,566

3.61

2.65

18.0

4.1

03/16

18,986

3,896

3.95

2.68

16.5

4.1

03/17e

21,204

4,432

4.43

2.72

14.7

4.2

03/18e

18,946

3,588

3.90

7.83

16.7

12.0

Note: Converted at US$1.24/£. Gross yield excludes withholding tax. Investors should consult their tax advisor regarding the application of any domestic and foreign tax laws.

UK asset sale soon to be completed…

Since the UK Gas Distribution business was put up for sale, National Grid’s (NG) solid underlying equity story has been overshadowed by the sales process. Now that buyers have been found, and cash returns are scheduled in calendar Q217, we believe the market can refocus on NG’s remaining businesses – UK Electric Transmission, UK Gas Transmission, US Regulated (Electricity Transmission, Electricity Distribution and Gas Transmission) – which all offer strong prospects and most of which are outperforming.

…allowing a renewed focus on fundamentals

NG’s key underlying attraction remains its highly visible, non-cyclical, regulated cash flows. We forecast that, by 2021, Grid will generate £23.8bn of post-tax operating cash flow. Additionally, NG’s asset base will grow, driven by an average annual capex spend of over £3.9bn, and dividends will grow every year across our forecast period. The asset base growth and a dividend yield of 4.3% give what Grid’s management refers to as total shareholder returns (TSR) of nearly 10%.

Valuation: $69.40/ADR, but beware rising bond yields

We use a blended average of a sum-of-the-parts valuation and a peer-based multiple model. Our SOTP is driven by a segment-based premium to regulatory asset value (RAV)/asset base model, which implies a fair value per ADR of $63.90, while our multiple-derived model offers a fair value per ADR of $74.90. The average of $69.40 offers equity holders 9.1% upside to current levels. We highlight rising government bond yields as a key risk for investors owing to NG’s bond proxy status.

Investment summary: Refocus post disposal

Company description: Stability, growth, returns

Due to its unique end-market exposure to UK and US regulated power and gas infrastructure, National Grid is able to offer US-based ADR holders solid asset-backed returns, supported by well-established regulatory regimes. 5-7% asset growth coupled with an attractive yield of 4.3% (based on $63.62/ADR) gives equity holders an attractive combination of growth and income. With the disposal of its UK Gas Distribution business for an implied EV of £13.8bn ($17.25bn) and a cash consideration of £5.4bn ($6.75bn), management has demonstrated an admirable focus on crystallising value for shareholders. Now that the deal has completed, NG’s leadership can continue to focus its energies on unlocking shareholder value by engaging with regulators in the US and UK and continuing with its five-year £21.5bn ($26.9bn) investment plan (note, this plan will be reduced following the disposal), ensuring continued long-term shareholder value.

Valuation: 9% upside, but rising yields a risk

Our fair value per ADR of $69.40 is derived firstly from a sum-of-the-parts model, which is driven by a segment premium to RAV model. We also factor in relative EV/EBITDA multiples of national Grid’s closest peers in arriving at our fair value per ADR. Investors should be aware of two key risks for the stock:

Macro issues: historically, NG’s share price has moved inversely to long-dated UK government bonds. We explore this in our valuation section, but we highlight this as a key risk for equity holders, especially as central banks globally consider tightening.

Technical issues: around £4.0bn of the £5.4bn ($6.75bn) proceeds from the UK Gas Distribution sale will be returned to shareholders in early 2017. This could distort the share price in the coming months. As could the share colsolidation.

Financials: Better FY17 and disposal in FY18

Due to the regulated nature of Grid’s businesses, there is little change to our last set of published numbers from November 2016 in the near term. Grid released technical guidance in March that indicated that due to “overcollection” in both the US and UK, the company will generate earnings ahead of expectations although this is a temporary phenomenon. The biggest change is obviously in FY18, when the company will deconsolidate the UK Gas Distribution business and account for the remaining 39% stake as an associate. Finally, since we last published, the pound has weakened from $1.30 to $1.29 (although our central FX assumption is $1.24). For an underlying forecast change table in sterling as reported, see Exhibit 14.

Exhibit 1: Forecast change table

EPADR (US$)

PTP (US$m)

EBITDA (US$m)

Old

New

% chg.

Old

New

% chg.

Old

New

% chg.

2017e

4.22

4.43

+5.0

4,202

4,432

+5.5

7,573

7,876

+4.0

2018e

4.39

3.90

-11.1

4,399

3,588

-18.5

7,907

6,112

-22.7

Source: Edison Investment Research


An attractive mix of stable growth and high returns

NG’s core competencies are managing relationships with utility regulators and other stakeholders and managing significant infrastructure investments. By combining those skill sets and relationships, the group has been able to deliver solid growth and returns for shareholders thanks to its outperformance versus its allowed returns.

Strategy: A focus on higher-growth, regulated utility networks

National Grid owns and operates a unique geographical combination of regulated gas and electricity networks in the US and UK. The company has accumulated the high degree of necessary competence in engagement with regulators, government agencies and consumer groups to enable the strong operational performance of its networks. The recent disposal of the UK Gas Distribution business shows Grid’s commitment to higher-growth businesses and its determination to crystallise value for shareholders.

Value driven by asset growth and shareholder returns

National Grid’s regulated asset base (‘RAV’ in the UK and ‘rate base’ in the US) underpins shareholder returns and the stock’s equity valuation. The interests of energy consumers as well as National Grid’s shareholders are aligned provided the company can grow its asset base by investing efficiently in grid enhancements. We are confident Grid will meet its stated objectives of growing its assets by 5-7% per year in constant currency terms. On top of this, equity holders also benefit from a generous dividend payout (63% of underlying earnings, growing at UK retail price index [RPI]), which gives a yield of 4.3% based on the current price.

Exhibit 2: Divisional summary and targets

Operating segment

FY16 RAV

FY16 ROE

Notes

Group targets

UK Electricity Transmission

£11.8bn

13.9%
(370bp outperf)

Delivering investment and efficiency as planned. Preparing for competition.

RAV growth 5-7%

Group FY16 ROE target was 12%

UK regulated operations to outperform by 200-300bp

Return proceeds from gas disposal to shareholders

Improve US returns

Grow dividend by at least RPI

UK Gas Transmission

£5.6bn

12.5%
(250bp outperf)

Continuing to deliver efficiency and reliability as agreed with regulator.

UK Gas Distribution

£8.7bn

13.0%
(310bp outperf)

Disposed – cash return in calendar Q217.

US Regulated

$18.3bn

8.0%

KEDNY/KEDLI, Niagara Mohawk, MA Electric all filed. MA GAS, N Mohawk in FY17.

Source: National Grid, Edison Investment Research

UK Business

A long-established privatised utility network, which has proved an attractive draw for international capital, the UK electricity and gas grid has undergone significant regulatory changes in recent years. Introduced in 2013, the RIIO (Revenue = Incentives + Innovation + Outputs) system replaced the RPI-X regime in place since 1990 and seeks to encourage innovation in a rapidly evolving energy landscape characterised by high levels of renewable capacity requiring grid connection as well as more traditional maintenance and replacement. The economic benefits of efficiencies gained by owner operators, such as National Grid, are split between utilities and consumers.

Exhibit 3: UK RIIO regulatory system

Source: National Grid, Edison Investment Research

On top of ‘totex incentives’, which split the economic benefits of efficiencies found by network operators such as NG (£330m for customers in the first three years of RIIO), meeting further incentives such as reliability targets and customer satisfaction brings the potential for increased outperformance. By performing well on these issues as well as efficiencies, Grid was able to outperform versus its base regulatory returns on equity in FY16 (UK Electricity Transmission 13.9% RoE – 370bp outperformance, UK Gas Transmission 12.5% RoE – 250bp outperformance, UK Gas Distribution 13.0% – 310bp outperformance).

The final, potentially longer-term component of the RIIO framework is ‘Innovation’, which is intended to encourage companies such as NG to invest in new capabilities, in particular with regard to connecting renewables generation capacity as it comes on stream. The RIIO framework encourages companies to find cost-efficient solutions to issues that arise as the grid evolves.

Electricity Transmission

With a 14% increase in H117 operating profit to £697m (FY16 RoE 13.9%), albeit due to timing benefits, UK Electricity Transmission (UKET) is expected to turn in a slightly lower RoE for FY17 as the totex incentive is reduced. At the half year, capex was up by 14% to £586m, which is a good driver of long-term shareholder returns.

Exhibit 4: NG UK Electric Transmission key financial indicators

Source: National Grid, Edison Investment Research

UKET aims to continue investing, with RAV growth expected to be 6% per annum to 2021, while outperformance should come from continuing management attention on efficiency and innovation.

Exhibit 5: NG UK Electric Transmission returns

Source: National Grid, Edison Investment Research

Gas Transmission

UK Gas Transmission’s (UKGT) H117 operating profit of £159m was flat half-on-half (FY16 RoE 12.5%), with less favourable timing behind the performance. Capital investment of £116m at H117 was up 27% versus H116.

Exhibit 6: NG UK Gas Transmission key financial indicators

Source: National Grid, Edison Investment Research

UKGT expects its RAV to grow ahead of RPI in FY17 and the unit continues to focus on improving its totex efficiencies after narrowly missing out on its totex objective in FY16. That said, it aims to continue to perform well versus its other incentives, which drove 120bp of outperformance in FY16.

Exhibit 7: NG UK Gas Transmission returns

Source: National Grid, Edison Investment Research

In its role as system operator, UKGT has managed the gas network well, including during periods of high demand, such as winter 2015/16

Gas Distribution: Sales proceeds to be returned to shareholders

UK Gas Distribution (UKGD) returned an operating profit of £403m at H117 (FY16 RoE 13.0%), which was a reduction of 5.8% on the same period a year earlier owing to unfavourable timing. Management is upbeat on the outlook for RoEs in this business as it performs very well versus its incentives. It is the only UK unit where management expects RoEs to increase in FY17 vs FY16. However, in UKGD the main story was the recently completed sale process. We have deconsolidated UKGD from our group EBIT forecasts and include it as an associate from FY18. We have also adjusted our cash flow statement and balance sheet for the cash inflows, debt deconsolidation and shareholder returns in the form of a special dividend and buy back.

Exhibit 8: NG UK Gas Distribution key financial indicators

Source: National Grid, Edison Investment Research

A special situation: Sales process complete

In 2015 NG management announced it was exploring a majority sale of its UKGD business. This was to reflect its apparently less attractive growth profile and underscores management’s focus on realising value for shareholders. In December 2016, the company said it had found a buyer for 61% of the business: a consortium of investors including Macquarie and China Investment Corporation. The £13.6bn valuation is 28% higher than our sum-of-the-parts valuation of £10.7bn and management has said it will return £4.0bn of proceeds (£5.4bn gross cash proceeds net of costs and some retained cash) to shareholders £3.2bn will be returned via a special dividend on June 2nd and the remainder will be returned via a buy back.

Exhibit 9: NG UK gas distribution returns

Source: National Grid, Edison Investment Research

From the beginning of FY18, the remaining 39% of the UKGD business will be accounted for in the associates and JVs line in the main P&L. We have deconsolidated the unit from our group earnings forecasts from FY18e and adjusted our sum-of-the-parts group valuation.

US Business: Addressing underperformance

With operations across New York State and New England, NG’s US business has gas and electricity infrastructure in attractive end markets in the US. In recent years, Grid’s US business has fallen behind in lodging rate filings, with the result that RoEs in the division have declined to 8.0%. As a rule of thumb, strongly performing regulated US utilities should be achieving RoEs at 90-95% of their allowed returns. The 12% increase in operating profit to £435m at H117 was a result of the strengthening dollar and favourable timing. Capex of £1,039m was up £39m in constant currency. We forecast US capex will continue to rise given the number of rate filings underway.

Playing catch up with the regulator

Exhibit 10: NG US rate base (US$m)

2016

2017e

2018e

2019e

2020e

2021e

Long Island (KEDLI)

2,176

2,343

2,496

2,703

2,893

3,043

Downstate New York (KEDNY)

2,525

2,718

2,896

3,136

3,357

3,531

Upstate New York (NMPC Gas)

1,160

1,249

1,330

1,441

1,542

1,622

Upstate New York (NMPC Electric)

4,621

4,975

5,300

5,740

6,143

6,461

Massachusetts Electric

2,156

2,321

2,473

2,678

2,866

3,015

Massachusetts Gas

1,945

2,094

2,231

2,416

2,586

2,720

Narragansett Distribution (Electric and Gas)

1,234

1,329

1,415

1,533

1,640

1,725

New England Power

1,405

1,513

1,611

1,745

1,868

1,965

Narragansett Electric (Transmission)

608

655

697

755

808

850

Canadian Interconnector

11

12

13

14

15

15

Long Island Generation

420

452

482

522

558

587

Total US rate base

18,261

19,660

20,943

22,682

24,275

25,534

Growth

7.7%

6.5%

8.3%

7.0%

5.2%

New York Jurisdiction

10,482

11,285

12,022

13,019

13,934

14,657

Massachusetts and Rhode Island Jurisdiction

5,335

5,744

6,119

6,627

7,092

7,460

FERC Jurisdiction

2,444

2,631

2,803

3,036

3,249

3,417

Total US rate base

18,261

19,660

20,943

22,682

24,275

25,534

Source: National Grid, Edison Investment Research

Currently Grid is in the process of playing catch up with the regulator across several jurisdictions. For instance, at the half year, management stated that, upon approval, KEDNY and KEDLI were expected to be awarded an allowed return of 9% versus the 7.1% and 7.3% they achieved in FY16. Niagara Mohawk is also expected to see an increase in achieved return.

Exhibit 11: NG US RoEs

2016

2017e

2018e

2019e

2020e

2021e

Long Island (KEDLI)

7.3%

7.3%

7.3%

7.3%

7.3%

7.3%

Downstate New York (KEDNY)

7.1%

7.1%

7.1%

7.1%

7.1%

7.1%

Upstate New York (NMPC Gas)

8.4%

8.4%

8.4%

8.4%

8.4%

8.4%

Upstate New York (NMPC Electric)

8.1%

8.1%

8.1%

8.1%

8.1%

8.1%

Massachusetts Electric

10.4%

10.4%

10.4%

10.4%

10.4%

10.4%

Massachusetts Gas

8.4%

8.4%

8.4%

8.4%

8.4%

8.4%

Narragansett Distribution (Electric and Gas)

10.2%

10.2%

10.2%

10.2%

10.2%

10.2%

New England Power

11.0%

11.0%

11.0%

11.0%

11.0%

11.0%

Narragansett Electric (Transmission)

11.2%

11.2%

11.2%

11.2%

11.2%

11.2%

Canadian Interconnector

13.0%

13.0%

13.0%

13.0%

13.0%

13.0%

Long Island Generation

12.5%

12.5%

12.5%

12.5%

12.5%

12.5%

Total US RoE

8.0%

8.6%

8.6%

8.6%

8.6%

8.6%

Source: National Grid, Edison Investment Research

Investing for growth and returns

NG and its regulators work together to devise long-term capex programmes for the businesses, which grow the asset base (the bedrock of NG’s valuation) and, in turn, ensure regulated, visible, growing cash flows that cover Grid’s dividend requirements and go some way to funding future capex projects.

Capex: Driving asset growth and tomorrow’s returns

NG targets 5-7% asset growth. NG’s total capex budget over the next five years will be funded by a mixture of internal cash flows and net debt issuance. We have removed the UKGD capex from our forecasts from FY18e.

Exhibit 12: NG group capex forecasts

Source: National Grid, Edison Investment Research

Divestments and returns: A key part of the story

Grid’s ongoing businesses provide shareholders with a healthy yield of 4.3%. The UKGD disposal shows a clear management focus on shareholder value, as does the dividend policy of growing DPS at least in line with UK RPI inflation. The company has announced the proposed schedule for a £4bn shareholder return programme. £3.2bn will be delivered via a special dividend due to be paid on 2 June. The remainder will be returned via a buy back. After the special dividend there will be a share consolidation (11 for 12) after which the dividend policy will be to continue growing payouts at or above RPI. We include all company guidance in our forecasts.

Exhibit 13: National Grid EPS and DPS forecast

Source: National Grid, Edison Investment Research


Financials

Due to the nature of National Grid’s regulated earnings, we are making minimal changes to our earnings forecasts to reflect timing issues, inflation differences and currency movements. The main change we have made is to deconsolidate UKGD from FY18, which reduces our EBITDA considerably, although the impact at the EPS level is partly offset as the earnings come through in the associates line. Capex is reduced as UKGD’s capex requirement will no longer be accounted for at group level. Net debt is significantly lower due to the cash inflow from the sale together with the deconsolidation of UKGD’s debt. A full set of financial forecasts can be found in Exhibit 20.

Exhibit 14: Detailed forecast changes

2016

2017e

2018e

New EBITDA (£m)

5,710

6,352

4,929

Old EBITDA (£m)

5,710

5,826

6,082

± New vs old

 

9.0%

-19.0%

New EBIT (£m)

4,096

4,664

3,482

Old EBIT (£m)

4,096

4,163

4,361

± New vs old

 

12.0%

-20.2%

New EPS (p)

69.00

71.36

64.26

Old EPS (p)

69.00

65.10

67.59

± New vs old

 

9.6%

-4.9%

New DPS (p)

43.16

43.81

129.28

Old DPS (p)

43.71

44.80

45.92

± New vs old

 

-2.2%

181.5%

New capex (£m)

(3,408)

(3,659)

(3,312)

Old capex (£m)

(3,408)

(4,015)

(4,178)

± New vs old

 

-8.9%

-20.7%

New net debt (NG definition) (£m)

25,325

13,860

18,226

Old net debt (NG definition) (£m)

25,325

26,548

27,759

± New vs old

 

-47.8%

-34.3%

Source: Edison Investment Research

Earnings: Ahead of an (unreliable) consensus

Given that Grid recently disposed of UKGD, we have little confidence in the consistency of approach in consensus estimates. We have formed our view on earnings based on actual numbers, H117 technical guidance and regular communication with the company. Meanwhile, we forecast that NG’s DPS (underlying and excluding the special dividend) will compound by an average of 2.3% across our five-year forecast horizon.

Exhibit 15: Edison forecasts vs consensus

Year-end 31 March

2016

2017e

2018e

Edison revenues (£m)

15,311

17,100

15,279

Bloomberg revenues (£m)

 

15,853

16,042

± Edison vs consensus

 

7.9%

-4.8%

Edison EBITDA (£m)

5,710

6,352

4,929

Bloomberg EBITDA (£m)

 

5,897

5,387

± Edison vs consensus

 

7.7%

-8.5%

Edison EBIT (£m)

4,096

4,664

3,482

Bloomberg EBIT (£m)

 

4,262

3,887

± Edison vs consensus

 

9.4%

-10.4%

Edison EPS (pence per share)

69.00

71.36

64.26

Bloomberg EPS (pence per share)

 

63.80

64.70

± Edison vs consensus

 

11.8%

-0.7%

Edison DPS (pence per share)

43.16

43.81

129.28

Bloomberg DPS (pence per share)

 

44.30

45.70

± Edison vs consensus

 

-1.1%

182.9%

Edison capex (£m)

(3,408)

(3,659)

(3,312)

Bloomberg capex (£m)

 

(3,994)

(3,750)

± Edison vs consensus

 

-8.4%

-11.7%

Edison net debt (company definition) (£m)

25,325

13,860

18,226

Bloomberg net debt (£m)

 

25,702

25,306

± Edison vs consensus

 

-46.1%

-28.0%

Source: Edison Investment Research, Bloomberg data. Note: Data as at 30 April 2017.

Cash flow

Between FY17e and FY21e, we forecast Grid will produce £23.8bn of after tax operating cash flow, which more than covers the £19.4bn capex requirement over the same period. The £9.6bn we forecast in dividend payments over this period includes the £3.2bn one-off return from the UKGD disposal.

Balance sheet

To those unfamiliar with regulated utilities, our forecast for NG’s headline net debt to EBITDA multiple of 3.7x for FY18e may look stretched. However, regulated returns are designed to cover capital investment, shareholder returns and interest payments and ensure that Grid will generate more than enough cash to cover all of its commitments. P&L interest cover averages 3.96x over our forecast horizon, while funds from operations (FFO) interest cover was 5.5x at FY16. Retained cash flow (RCF) to net debt at FY16 was 11.5% and FFO to net debt was 16.7%. Both these figures are within parameters that regulators and ratings agencies view as sensible. We view NG’s key credit metrics as conservative. Net debt as a portion of total regulatory value for NG was 62% at FY16, in line with regulatory assumptions. In short, NG manages its cash flows and treasury functions proactively and conservatively, with the result that it has more than sufficient headroom to finance £2-3bn of cash flow requirements per year at historically low interest rates.

Valuation methodologies

We take several valuation methodologies into account in arriving at our fair value per share.

1.

Our first valuation methodology for NG is a sum-of-the-parts model, driven by a segment-level RAV premium model.

2.

We average our premium to RAV model with a sector multiple-based model. Our peer comparison data are in Exhibit 17 and we believe EV/EBITDA is the most relevant comparable ratio.

3.

We also take account of NG’s share performance in relation to UK 10-year bond yields to show the inverse correlation.

The blended average of our premium to RAV fair value per ADR of $63.90 and our peer comparison-derived fair value per share of $74.90 is $69.40. This implies upside of 9.1% to the current share price.

Sum-of-the-parts using segment RAV premium

For regulated businesses, the usual valuation methodology is to use the asset base as a starting point and ascribe a premium or discount depending on the economic value of outperformance or underperformance. Using this method for NG, we arrive at a fair value per ADR of $63.90, or 0.4% upside to the current price of $63.62/ADR.

Exhibit 16: National Grid sum-of-the-parts

Sum of the parts

£m

pence/share

US$m

US$/ADR

UKET RAV

12,083

322

14,983

19.98

Premium

4,190

112

5,196

6.93

% premium to RAV

34.7%

UKGT RAV

5,712

152

7,083

9.44

Premium

1,659

44

2,057

2.74

% premium to RAV

29.0%

Total UK Regulated (£m)

23,645

630

29,319

39.10

US Rate base ($m)

16,890

450

16,890

22.52

P/B (x)

1.45

Total US Regulated ($m)

24,490

526

24,490

32.66

Total US Regulated (£m)

19,750

526

24,490

32.66

Other Activities

510

EBITDA Multiple

11.0

Total other Activities (£m)

5,608

149

6,954

9.27

Equity stake in UKGD (18x P/E)

3,500

93

4,340

5.79

Total Enterprise value £m (UK + US + Other)

52,503

1,399

60,763

86.8

Less net debt

13,860

369

17,186

22.92

Equity value (£m)

38,643

1,030

43,577

63.9

Market price

987.0

63.62

Upside/(downside)

4.3%

0.4%

£/US$

1.24

Number of shares (m)

3,752.0

Number of ADRs (m)

749.9

Source: Edison Investment Research

Note: we arrive at a fair premium or discount to RAV based on a net present value calculation of the economic outperformance of each unit versus its required return. We use 18x P/E for the UKGD equity stake as it is in line with other listed UK regulated utilities (see Exhibit 17).

Peer multiples

NG trades at attractive levels in comparison to its closest listed UK and international peers. Grid trades on a 4.3% one-year forward dividend yield (ahead of its closest UK peers on 3.9%). Also, on one-year forward EV/EBITDA, Grid trades at a 9.3% discount to a global average of 11.1x. To reinforce the point that regulated utilities can sustain high levels of debt and that NG is actually conservatively geared, its one-year forward net debt to EBITDA of 3.7x is actually well below the global average of 4.5x.

Exhibit 17: National Grid vs peers

Company

Share Price (local)

Market cap (local m)

Dividend yield

Current P/E

Next P/E

Current EV/ EBITDA

Next EV/ EBITDA

FCF Yield

Net debt to +1y EBITDA

Snam SpA

4.08

14,290

5.1%

15.5x

15.1x

12.6x

12.4x

7.5%

5.5x

Terna Rete Elettrica Nazionale SpA

4.68

9,415

4.4%

14.1x

13.9x

11.1x

10.9x

-6.3%

5.2x

Enagas SA

24.25

5,789

5.6%

13.0x

13.5x

10.3x

10.5x

8.1%

4.4x

Red Electrica Corp SA

18.05

9,766

4.4%

14.5x

13.9x

10.2x

9.9x

8.3%

3.8x

Average Regulated Europe

 

 

5.0%

14.2x

14.2x

11.4x

11.3x

3.1%

5.0x

Pennon Group PLC

867

3,608

4.1%

20.1x

19.5x

12.7x

12.2x

-1.4%

1.6x

United Utilities Group PLC

867

6,710

4.0%

21.6x

21.5x

13.7x

13.2x

0.7%

6.9x

Severn Trent PLC

984

5,445

3.5%

21.8x

21.1x

12.2x

11.8x

1.4%

4.9x

Average UK

 

 

4.5%

17.7x

17.4x

12.1x

11.8x

1.7%

4.8x

Consolidated Edison Inc

80

24,336

3.4%

19.6x

18.7x

10.2x

9.6x

-1.6%

2.5x

PPL Corp

38

25,972

4.0%

17.7x

16.4x

11.6x

10.6x

-4.2%

4.9x

Average US

 

 

3.7%

18.6x

17.6x

10.9x

10.1x

-2.9%

3.7x

Average Global

 

 

4.7%

16.8x

16.4x

11.5x

11.1x

0.6%

4.5x

National Grid PLC

1,007

37,761

4.3%

15.5x

15.6x

8.0x

10.3x

0.0%

3.7x

Source: Bloomberg data, 27.04.17

If we apply a 12.0x one-year forward EV/EBITDA in line with the top of the range for NG’s global peers, our fair value per ADR increases to $74.90, offering 17.7% upside.

Exhibit 18: NG fair value per ADR at market average EV/EBITDA

£m

Current EV/EBITDA

FV/ADR at 12.0x ($)

Upside/(downside) %

FY18e EBITDA

4,929

10.33

74.9

17.7%

Source: Edison Investment Research

Bond proxy: Rising inflation and long-term yields a risk

Exhibit 19: NG share price vs inverted UK 10-year bond yields

Source: Bloomberg data, 20 April 2017

We note that a serious risk to NG’s share price is rising yields on long-dated UK bonds. As NG is a bond proxy, most investors require a premium to risk-free assets, so rising yields in gilts have historically been associated with a falling NG share price. The underperformance in the stock since summer 2016 demonstrates this.

Exhibit 20: Financial summary

$m

2015

2016

2017e

2018e

2019e

2020e

2021e

Year end 31 March

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

19,777

18,986

21,204

18,946

19,853

20,418

20,972

EBITDA

 

 

6,628

7,080

7,876

6,112

6,574

6,775

6,957

Operating Profit (before amort. and except.)

4,790

5,079

5,784

4,317

4,671

4,768

4,855

Intangible Amortisation

0

0

0

0

0

0

0

Exceptionals

(103)

(14)

0

0

0

0

0

Operating Profit

4,687

5,065

5,784

4,317

4,671

4,768

4,855

Associated company

57

73

75

319

335

338

344

Exceptionals

(308)

(136)

0

0

0

0

0

Net Interest

(1,281)

(1,256)

(1,428)

(1,048)

(1,165)

(1,291)

(1,381)

Pre-Tax Profit (norm)

 

 

3,566

3,896

4,432

3,588

3,841

3,815

3,818

Pre-Tax Profit (IFRS)

 

 

3,156

3,746

4,432

3,588

3,841

3,815

3,818

Tax

(862)

(934)

(1,108)

(861)

(922)

(916)

(916)

Profit After Tax (norm)

2,704

2,962

3,324

2,727

2,919

2,899

2,902

Profit After Tax (IFRS)

2,294

2,812

3,324

2,727

2,919

2,899

2,902

0.0

0.0

0.0

0.0

0.0

0.0

0.0

Average Number of ADR Outstanding (m)

749.9

749.9

749.9

699.4

687.4

687.4

687.4

EPADR - normalised ($)

 

 

3.61

3.95

4.43

3.90

4.25

4.22

4.22

EPADR - (IFRS) ($)

 

 

3.06

3.75

4.43

3.90

4.25

4.22

4.22

DPADR ($)

2.65

2.68

2.72

7.83

2.77

2.84

2.91

EBITDA Margin (%)

33.5

37.3

37.1

32.3

33.1

33.2

33.2

Operating Margin (before GW and except.) (%)

24.2

26.8

27.3

22.8

23.5

23.4

23.2

BALANCE SHEET

Fixed Assets

 

 

60,832

65,251

52,320

54,632

58,147

61,340

63,989

Intangible Assets

7,374

7,690

7,690

7,690

7,690

7,690

7,690

Tangible Assets

53,063

57,069

44,137

46,450

49,964

53,157

55,806

Investments

394

492

492

492

492

492

492

Current Assets

 

 

7,478

7,827

14,852

11,297

12,517

12,751

13,482

Stocks

422

542

542

542

542

542

542

Debtors

3,517

3,065

3,065

3,065

3,065

3,065

3,065

Cash

148

157

7,183

2,388

3,608

3,842

4,573

Other

3,393

4,062

4,062

5,302

5,302

5,302

5,302

Current Liabilities

 

 

(8,065)

(8,864)

(8,864)

(8,864)

(8,864)

(8,864)

(8,864)

Creditors

(4,310)

(4,386)

(4,386)

(4,386)

(4,386)

(4,386)

(4,386)

Short term borrowings

(3,755)

(4,478)

(4,478)

(4,478)

(4,478)

(4,478)

(4,478)

Long Term Liabilities

 

 

(44,319)

(46,684)

(39,492)

(41,352)

(45,072)

(47,552)

(50,032)

Long term borrowings

(28,374)

(30,669)

(23,477)

(25,337)

(29,057)

(31,537)

(34,017)

Other long term liabilities

(15,945)

(16,015)

(16,015)

(16,015)

(16,015)

(16,015)

(16,015)

Net Assets

 

 

15,927

17,531

18,817

15,715

16,729

17,676

18,576

CASH FLOW

Operating Cash Flow

 

 

6,634

7,018

7,876

6,112

6,574

6,775

6,957

Net Interest

(1,281)

(1,256)

(1,428)

(1,048)

(1,165)

(1,291)

(1,381)

Tax

(425)

(362)

(1,108)

(861)

(922)

(916)

(916)

Capex

(3,814)

(4,226)

(4,537)

(4,107)

(5,417)

(5,200)

(4,751)

Acquisitions/disposals

(246)

(412)

6,696

0

0

0

0

Financing

(399)

(319)

(292)

(1,264)

(8)

(13)

(16)

Dividends

(1,576)

(1,658)

(1,671)

(5,486)

(1,562)

(1,601)

(1,641)

Net Cash Flow

(1,107)

(1,214)

5,537

(6,654)

(2,500)

(2,246)

(1,749)

Opening net debt/(cash)

 

 

31,739

31,981

34,989

20,772

27,427

29,927

32,173

HP finance leases initiated

0

0

0

0

0

0

0

Other

866

(1,794)

8,680

(0)

0

(0)

(0)

Closing net debt/(cash)

 

 

31,981

34,989

20,772

27,427

29,927

32,173

33,922

Source: National Grid accounts, Edison Investment Research

Contact details

Revenue by geography (FY16)

National Grid
4th Floor, 1-3 Strand
London
WC2N 5EH
+44 (0)20 7004 3000
www2.nationalgrid.com

Contact details

National Grid
4th Floor, 1-3 Strand
London
WC2N 5EH
+44 (0)20 7004 3000
www2.nationalgrid.com

Revenue by geography (FY16)

Management team

CEO: John Pettigrew

CFO: Andrew Bonfield

John Pettigrew joined the company in 1991 and has over 25 years of experience at National Grid in a variety of senior management roles. Mr Pettigrew’s previous appointments include director of engineering from 2003, chief operating officer and executive vice president for the US Electricity Distribution & Generation business between 2007 and 2010, chief operating officer for UK Gas Distribution between 2010 and 2012, and UK chief operating officer from 2012 to 2014. John was appointed to the role of chief executive on 1 April 2016.

Andrew Bonfield was appointed CFO of National Grid and to the board as executive director in 2010. Previously, he was CFO at Cadbury, following a previous CFO role at Bristol-Myers Squibb based in New Jersey and an energy sector role as finance director of BG Group. Mr Bonfield is a qualified chartered accountant.

Management team

CEO: John Pettigrew

John Pettigrew joined the company in 1991 and has over 25 years of experience at National Grid in a variety of senior management roles. Mr Pettigrew’s previous appointments include director of engineering from 2003, chief operating officer and executive vice president for the US Electricity Distribution & Generation business between 2007 and 2010, chief operating officer for UK Gas Distribution between 2010 and 2012, and UK chief operating officer from 2012 to 2014. John was appointed to the role of chief executive on 1 April 2016.

CFO: Andrew Bonfield

Andrew Bonfield was appointed CFO of National Grid and to the board as executive director in 2010. Previously, he was CFO at Cadbury, following a previous CFO role at Bristol-Myers Squibb based in New Jersey and an energy sector role as finance director of BG Group. Mr Bonfield is a qualified chartered accountant.

Principal shareholders

(%)

Blackrock

6.8%

Norges

4.5%

L&G

4.0%

Vanguard

2.7%

HSBC

2.5%

State Street

2.1%

Companies named in this report

Pennon (PNN), Severn Trent (SVT), United Utilities (UU.), Terna (TRN), Snam Rete Gas (SRG), Enagas (ENG), Red Electrica (REE), Consolidated Edison (ED),

Northeast Utilities (NU), PPL Corporations (PPL).

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2017 Edison Investment Research Limited. All rights reserved. This report has been commissioned by National Grid and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document.
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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2017 Edison Investment Research Limited. All rights reserved. This report has been commissioned by National Grid and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document.
A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (ie without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2017. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Green Dragon Gas — ODP submission: Green shoots

2017 is likely to be a critical year for Green Dragon Gas (GDG) as management works to deliver on several milestones that will enable a step-up in activity levels. We were encouraged by the CNPC approval and submission of the GCZ CBM Block overall development plan (ODP) in April. Execution of supplementary agreements and GSS ODP submission would provide an incremental reserve base for GDG to leverage in order to refinance outstanding bonds and fund further drilling activity. With regard to funding GDG states that it has multiple term sheets for mezzanine and RBL funding on hand. Our base case valuation of 227p/share rises to 237p/share assuming GSS ODP approval this year and GCZ developed in-line with ODP, this is offset by a delay in GSS development relative to previous forecasts.

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