National Grid, one of the two surviving listed companies from Thatcher's privatization of the electricity industry, is a giant firm that owns the electric transmission systems of England and Wales, electricity distribution networks in England, Wales, New York, Massachusetts, and Rhode Island, as well as gas storage facilities and renewable resources. National Grid, like most utilities normally is in the headlines only when the lights go out. However, the company recently shocked the investment public when it announced financing for its £60 billion five-year capital spending program. The company intends to raise £6.8 billion by selling discounted common stock in a rights offering (7 new shares for every 24 owned) to its shareholders, which will increase the number of shares by roughly 29%. This is a monumental offering by European standards. Now for the bad news. In order to save cash for the big spending program, the company will "rebase" ( euphemism for "reduce") the common stock dividend so dividend outflow remains the same despite the higher number of shares outstanding. Not exactly share-owner-friendly. But let's be frank. Income-seeking investors with a low appetite for risk hate dividend cuts.
Financing the £60 billion capital program, we estimate, might look roughly like this (rounded): rights offering £7 billion, depreciation £12 billion, retained earnings £4 billion, sale of assets £4 billion, debt and other £32 billion. That's a lot of debt, but that is not what shocked the market. It was the size of the stock issue combined with a dividend cut. National Grid stock fell 20% in three days. Yet, even on a "rebased" basis, with a 4% dividend and a likely 6% growth rate, National Grid, to us, looks like a reasonable value. Stated differently, current income of 4% plus earnings growth of 6% suggests an implied total equity return for this company of 10%. That has traditionally been a very attractive level for a regulated utility. Maybe we are missing something.
But we aren't planning to discuss National Grid's prospects or its communications with share owners, but rather to point out that National Grid's capital program will lead to growth in capitalization of roughly 10% per year. But like many utilities, its internally generated funds might only furnish less than one-third of the money needed for its capital program. American utilities, with increasing capital programs for electrification, are headed in the same direction in terms of spending and financing. The only difference is that US companies will not sell one huge equity offering but rather a number of smaller ones. The end result is the same in terms of equity dilution but equity investor's feelings are less ruffled this way. Big electric utility spending plans will become commonplace. So will frequent common stock sales. Get used to them.
And finally, shareholders of a properly regulated US investor-owned utility do not suffer meaningful earnings dilution when the company sells a considerable amount of common stock. Quite the contrary. Earnings can grow by a lot because regulators authorize rate increases that permit actual eps growth. Bottom line? Income-oriented investors react emotionally to dividend cuts. Let's put it this way. A decently run utility with a 10% total return potential should not be sold.
By Leonard S. Hyman and William I. Tillles
Leonard S. Hyman is an economist and financial analyst specializing in the energy sector. He headed utility equity research at a major brokerage house and… More