A popular stock among income investors is energy distributor National Grid (LSE: NG). That is because the resilient demand for energy and limited industry competition often make for strong cash flows to fund dividends. But with news that the firm is selling a significant asset, is the National Grid dividend secure?
Sale of majority stake in large business
The company announced to the stock exchange today (although the notice was dated yesterday) that it has agreed to sell a 60% equity interest in its UK gas transmission and metering business. As well as £2.2bn in cash, the business is set to benefit from £4.2bn in debt financing. That means the whole of this unit is valued at £9.6bn overall. National Grid will be able to sell its remaining interest in the unit to the same buyer in the first half of next year on “broadly similar terms” to the transaction.
Subject to regulatory clearance, the deal is expected to complete in the second half of this year. The sale is part of National Grid’s strategic effort to focus on its electricity business.
What does this mean for the National Grid dividend?
Currently it is unclear whether selling the business will impact the National Grid dividend.
When a company sells a business, it often sees a fall in its overall income. That can make it harder to support the dividend. But that is not always the case. The sale proceeds can boost the balance sheet, or fund a special dividend. Sometimes, if a business unit is less profitable than the rest of the firm, selling it and reinvesting the proceeds in higher-margin areas can actually boost a company’s ability to make shareholder payouts.
In its announcement today, the company said that it expected the deal to enable it to maintain a strong balance sheet, thereby “supporting its sustainable dividend policy”. That is different to a progressive dividend policy where a company aims to raise its dividend annually. Instead, it means that the dividend can be sustained at its current level from the company’s earnings and cash flows.
So there is no word of a dividend cut. But regarding the long-term prospects for the National Grid dividend, I see the sale as introducing a new risk in the form of potentially lower earnings.
My next move on National Grid
Whether that leads to a flat or reduced dividend, only time will tell.
I like the resilience of electricity distribution as a business model. National Grid already has a strong position in that business area. Focusing on it more makes strategic sense to me. It could end up boosting income, and supporting bigger dividends.
But it also brings risks. Too much concentration in one business area can make a business less nimble. For example, the government could respond to spiralling energy costs by targeting electricity prices. That could hurt profits at a firm with heavy exposure to distributing electricity.
The National Grid share price moved less than 1% on this morning’s news but is up 29% over the past year. I do not think today’s news is necessarily negative for the dividend potential. But I do see it introducing an additional risk. I continue to think the 4.4%. yielding shares could offer an attractive passive income stream and would consider buying them for my portfolio.