Since regulators in the United Kingdom unbundled energy distribution, transmission, and supply in the Eighties, National Grid has grown into one of the largest utilities worldwide. Grid began acquiring Northeast U.S. utilities in 2000 and made its biggest move buying New York-based Keyspan for $11.8 billion in August 2007. It now drives about 40% of its profits from the U.S., but we expect that share to shrink as it focuses investment on the U.K., where the regulatory environment is more constructive.
With its U.K. rate structure set through 2021, Grid offers a transparent earnings and dividend growth trajectory. Even though the dividend likely won't grow at the 10% annual rate it did between 2005 and 2012, we still think it can grow faster than inflation. With its 5% dividend yield in mid-July, we think the stock offers attractive total returns given the stability of its business model.
National Grid reported 2013-14 half-year adjusted operating profit of £1.6 billion and 20.4p in earnings per share, both virtually flat with last year's half-year results this week.
Based on these results, National Grid is on track to approach our full-year estimates. We are reaffirming our belief that the company’s fair value is £8 per share, slightly more than the current trading level.
Higher costs at National Grid's U.S. utilities primarily for process improvements together with higher depreciation expense across all of its businesses offset significant year-over-year profit growth at the U.K. electricity transmission and U.K. gas distribution businesses. The electric transmission segment benefited from rate increases in April when its new eight-year RIIO rate cycle began.
Adjusting for the depreciation changes, operating cash flow was up 5%. We think this offers good support for dividend growth that we believe it can top the U.K. RPI inflation rate that management has suggested as a base growth rate.
Management reaffirmed its long-term growth plans that include £3.5 billion of capital investment in 2013-14 and a similar level in 2014-15, driving 6% annualised regulatory asset value growth. This is in line with our expectations and regulatory policy across its service territories, so we expect earnings and cash flow generally to track that growth pace. National Grid plans to pay a 2013-14 interim dividend of 14.49p on Jan. 22, flat with the 2012-13 interim dividend. We expect it will initiate its RPI-plus dividend growth policy with the 2013-14 final dividend in August.
