FTSE 100 stalwart National Grid (LSE: NG) has been on the slide, and today’s share price close to 789p is almost 30% lower than the peak in excess of 1,100p achieved in July 2016. There’s no sign of the downtrend stalling on the chart, so where will it end? Could the stock plunge as low as the 500p it last visited in 2010?
Stalled growth
The electricity and gas transmission and distribution operator has long been prized in the investing community for the defensive, cash-generating qualities of its business model. Holding the shares between 2010 and 2016 worked out well for many because rising revenue, profit and cash flow encouraged an upwards valuation re-rating that drove the share price ever higher.
But growth in revenue and earnings stalled in 2016 and have been weak since. The cash from operations figure dipped in the year to March 2018 too, and I think these wobbly financial figures are causing the market to re-evaluate its opinion about National Grid. If cash flow and earning don’t rise a little every year, is the firm as defensive as we previously assumed?
The directors speak of operational progress and record levels of investment. But that’s part of the firm’s problem, I reckon. Maintaining and developing the infrastructure for energy transmission and distribution is a capital-intensive pursuit, and there’s no getting out of it because of fierce regulation on both sides of the Atlantic where the company operates in Britain and the US. Ploughing big figures into the assets of the company means that the comparatively little figures for profit and cash inflow can be volatile and easily erased.
Fragile profits?
We could be seeing now that profits are more fragile than we thought, so does National Grid deserve the high-looking valuation the market was previously assigning it? I don’t think it does, and we seem to be seeing a valuation down-rating playing out, which could see the shares flying a lot lower yet. Today’s share price around 791p puts the price-to-earnings (P/E) ratio at just over 13 and the dividend yield at 5.8%. But City analysts following it expect earnings to go nowhere over the next couple of years, falling 3% this year and rising 3% next time. It’s easy to make a case for that valuation being too rich for a zero-growth proposition.
Assuming that earnings remain constant over the next couple of years, it would take a P/E ratio of around nine to get the share price down close to 500p. That seems within the realms of possibility to me, and even more likely if earnings slip further going forward. In a scenario like that, what would then be a high-looking dividend yield would be vulnerable to cutting anyway. I think National Grid has a lot to prove at the moment if it is to restore investor confidence and I’m in no hurry to pile into the shares.