Thursday, June 18, 2009

NGG – Stock Analysis for Dividend Growth Portfolio

National Grid plc (NGG) is a London based UK utility company. It owns and operates of regulated electricity and gas infrastructure networks in United Kingdom (Wales and Scotland) and North Eastern United States (upstate New York, NYC, Long Island, Massachusetts, New Hampshire, and Rhode Island). It served approximately 20 million consumers in the United Kingdom and the United States.

NGG is an international dividend achiever and has been paying growing dividends for last 12 years. In one of my earlier post, I listed few companies that may have potential for international dividend growth investments. I had shortlisted NGG for more analysis. Keeping with that, my objective here is to analyze if NGG is a good dividend growth stock and how it will rate on my scale of risk-to-dividends.

Trend Analysis
Here I am looking at trends for past 8 years of corporation’s revenue and profitability. These parameters should show consistently growth trends. The trend charts and data summary are shown in images below.

  • Revenue: Growing trends in revenue. The average revenue growth for last 8 years is 21.9% (with 42% standard deviation). Very high volatility. This is because of significant changes in revenue due to acquisitions.
  • Cash Flows: In general, an increasing trend for operating cash flow (except a dip in year 2004). The free cash flow as trended lower and is now less than net income. This would be a concern.
  • EPS from continuing operations: Consistently growing earnings after 2002.
  • Dividends per share: Consistently slow growth in dividends.

Risk Parameter Calculation
Here I use the corporation’s financial health to assign a risk number for measuring risk-to-dividends. The risk number for risk-to-dividends is 1.57. This is a medium risk category as per my 3-point risk scale.

Quality of Dividends
This section measures the dividend growth rate, duration of growth, consistency over a period of past five years.

  • Dividend growth rate: The average dividend growth of 7.8% (stdev. 21.79%) is less than average EPS growth rate of 48.9% (stdev. 76%). The dividends seem to be well covered and consistent with earnings growth. The higher standard deviation may indicate that dividends have negative growth rate (dividends cuts). However, that’s because of the currency fluctuations. NGG has been consistently growing dividends in its native currency.
  • Duration of dividend growth: 12 years.
  • 4 year rolling dividend growth rate for past ten years: Less than 10% for past 8 years. In native currency, it has been 4% to 8%
  • Payout factor: In the past 8 years, it has been in the varying over wide range. Since last four years, its trending downwards and now it is less than 50%.
  • Dividend cash flow vs. income from MMA: Here, I analyze how the dividend cash flow stacks up against the income from FDIC insured money market account. The baseline assumption is (a) stock is yielding 5.8%; and (b) MMA yield is 3.4%. With my projected dividend growth of 7.8%, the dividend cash flow is equal to 2.48 times MMA income.

Fair Value Calculation
This section determines what price I should pay to buy a given stock

  • Net present value (NPV) price based on 15 year DCF: $20.7
  • Average high yield price calculated based on past 8 years: $51.4
  • Pricing based on past 8 year relative price-to-earnings ratio: $73.8
  • Pricing based on price-to-earnings ratio of 12: $42.1
  • Graham number: $20.5

The range of fair value is calculated as $30.2 to $41.5.

Qualitative Analysis
NGG was primarily UK based utility company. Few years back it entered US markets by acquiring few regulatory businesses in north eastern part of the company.

  • It is a typical utility company with slow dividend growth but relatively higher dividend yield.
  • Its regulatory business gives it some level of stability in revenues. It is also continuing to invest in gas distribution and smart metering. It shows that it is not having problems in accessing capital.
  • The fluctuation in dividends is reflection of the impact of currency fluctuations.
  • Investing in NGG stock gives international exposure, hedge against dollar fluctuations, and hedge against increased energy commodity pricing. Regulatory businesses are able to pass on the higher cost to its customers slowly over a period of time.
  • It appears that debt increased year over year. Although, it is still below its historical levels, it is something that investors will need to keep track of.
  • Like any other company, I expect NGG to face challenges due to recession driven slow down. Consumers are likely to become more energy efficient and more conservative affecting the cash flow.

Conclusion
NGG is a international dividend achiever and has been raising dividends for last 12 years. The stocks current risk-to-dividend rating is 1.57 (medium risk). This is a typical utility stock with slow dividend growth. The projected dividend cash flow is 2.48 times MMA cash flow after 10 years (at price of $41.5). This analysis shows that NGG continues to be a good stock for potential international dividend growth investment. I already own common stock of NGG. I will be open adding to existing one as along as my allocation allows and it is within fair price range.

Full Disclosure: I am long on NGG.

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