National Grid (LSE: NG) shares have lost around 15% of their value since their 15 May 12-month high of £11.80.
For a company that owns and operates the electricity and gas transmission system in England and Wales, this surprises me.
Considering its underlying business, its share price, and its yield, I think it looks like a bargain now.
Underlying business strength
The company’s electricity and gas transmission monopoly means that it should benefit when the UK’s economy is strong.
But it is likely to continue making money even when times are tough economically. After all, people will always want to turn the lights on, heat their homes, and cook. Businesses in England and Wales will continue to need power too.
Its H1 2023/24 results covered the period when the UK’s cost-of-living crisis was near its peak. Although down 15% on the same period the previous year, the company still made an underlying profit of nearly £1.8bn.
As part of these results released on 9 November 2023, the firm maintained its five-year financial targets for 2020/21 to 2025/26.
These include an assets’ compound annual growth rate (CAGR) of 8%-10%, and an earnings per share (EPS) CAGR of 6%-8%.
Undervalued compared to its peers
The key stock risk is large debt accruing from regulator-directed investment in the England and Wales power grids.
At the time of its H1 results, it had £44.3bn of net debt. Positively, this was down from £50.5bn in the same period a year before.
However, this needs to be watched, in my view, as it could increase as the transition to greener energy accelerates.
Even with this factored into the share price, the stock looks undervalued to me.
As it stands, National Grid trades at a price-to-earnings (P/E) ratio of 14.5. Centrica is at 1.7, Sempra at 16, Telecom Plus at 16.5, and SSE at 29.1. This gives a peer group average of 15.8.
A discounted cash flow analysis shows its shares to be around 27% undervalued at their present price of £10.00. Therefore, a fair value would be about £13.70, although they may never reach that price, of course.
Increased dividends
In 2023, the company’s EPS jumped 22% to 74.2p. This allowed it to raise the dividend by 8.8% to 55.44p.
The H1 results also showed the latest interim dividend being raised by 8.8% — to 19.4p.
If this was applied to last year’s total payout then the stock would yield over 6%, based on the current share price.
Even without this, the yield of 5.5% compares very favourably to the FTSE 100 average of 3.9%.
Since I turned 50, my investment portfolio has mainly comprised shares yielding at least 7%. The few growth stocks I keep have generated double-digit percentage returns annually over the past few years.
National Grid does not fit into either category, but I think adding a utility to the portfolio might make sense.
A well-run utility offers returns in economic good times and bad. And National Grid also has the advantages of an undervalued share price in my view, plus a good yield.
