Should I Invest in National Grid?

LONDON -- To me, capital growth and dividend income are equally important. Together, they provide the total return from any share investment and, as you might expect, my aim is to invest in companies that can beat the total return delivered by the wider market.

To put that aim into perspective, the FTSE 100 has provided investors with a total return of around 3% per annum since January 2008.

Quality and value
If my investments are to outperform, I need to back companies that score well on several quality indicators and buy at prices that offer decent value.

So this series aims to identify appealing FTSE 100 investment opportunities and today I'm looking at National Grid  (LSE: NG  ) , which is well-known for operating Britain's gas and electricity transmission systems. It also runs a gas distribution business in Britain, and has gas and electricity assets in the U.S.

With the shares at 828 pence, National Grid's market cap. is £30,350 million.

This table summarizes the firm's recent financial record:

Year to March

2009

2010

2011

2012

2013

Revenue (£m)

15,624

14,007

14,343

13,832

14,359

Net cash from operations (£m)

3,413

4,516

4,858

4,228

3,750

Adjusted earnings per share

50.2p

55.05p

50.9p

50p

56.1p

Dividend per share

35.64p

38.49p

36.37p

39.28p

40.85p

Think big pylons and huge underground gas pipes and you are thinking of Britain's gas and electricity transmission systems. It's how we move gas and electrical energy long distances to where it's needed around the country. Running those transmission systems is part of what National Grid does. Last year, the firm earned around 44% of its operating profits that way. It's a capital-intensive business with captive consumers, reliable cash flows and fierce regulation.

A further 22% of profits came from operating four of the nation's eight regional gas distribution networks and 34% of profits came from the company's interests in the north eastern U.S., where

the firm's regulated business includes electricity generation, transmission and distribution assets, and gas distribution networks.

If National Grid can keep balancing capital expenditure, regulatory compliance and interest payments, the steady cash flow generated should continue to filter down into steadily rising dividends, which is an important component of total returns.

National Grid's total-return potential
Let's examine five indicators to help judge the quality of the company's total-return potential:

  1. Dividend cover: adjusted earnings covered the last dividend around 1.4 times. 3/5
  2. Borrowings: net debt around 7.3 times operating profit with 4.4 times interest cover. 3/5
  3. Growth: revenue and earnings have recently grown with decent cash flow support. 4/5
  4. Price to earnings: a forward 14 or so looks ahead of growth and yield expectations. 2/5
  5. Outlook: good recent trading and a positive outlook. 5/5

Overall, I score National Grid 17 out of 25, which encourages me to believe the firm has potential to out-pace the wider market's total return, going forward.

Foolish summary
Strong cash flow supports interest and dividend payments. Recent trading has been good and the positive outlook is encouraging. Such attributes seem to reflect in the current valuation. I'm watching National Grid, which looks worth buying on the dips.

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