Following 
National Grid’s (NG.) recent fiscal year-end 2015 results, updates to Ofgem’s regulatory framework and rates (RIIO) and a review of current exchange rates, Morningstar analysts have cut their fair value estimate on the energy provider’s shares to 800p per share from 815p.
With its UK rate structure set through to 2021, National Grid offers transparent earnings and dividend growth. Even though the dividend is unlikely to grow at the 10% annual clip it did between 2005 and 2012, we still think it can grow in line with—or faster than—inflation. With a dividend yield that has been consistently above 5%, we think the stock offers attractive total returns given the stability of its business model.
The key for National Grid is delivering and optimising its eight-year UK investment plan, which it recently cut back to £16 billion-£20 billion from £26 billion based on delays in expected new generation interconnections. We forecast 3% annual operating profit growth through to 2019. Our new forecast assumes that National Grid invests £9 billion in fiscal 2016-19. We continue to assume £4.9 billion of investment in the US during the same period.
Service territory monopolies and efficient-scale advantages are the primary sources of economic moat—a measure of sustainable competitive advantage—for regulated utilities like National Grid. Regulators where National Grid operates, in the UK and the north-east of the US, grant the firm exclusive rights to charge customers rates that allow it to earn a fair return on the capital it invests. In exchange, regulators set returns at levels that aim to minimise customer costs while offering fair returns for capital providers. This implicit contract between regulators and capital providers should, on balance, allow National Grid to earn at least its cost of capital, though we may see returns vary in the short run.
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