LONDON -- Moats were once essential for keeping intruders out of castles, because they presented a simple but effective barrier to entry. Today, they are just as useful for keeping would-be competitors away from profitable businesses, but they come in many more shapes and sizes.
Although big miners like Rio Tinto or BHP Billiton might still rely on large holes in the ground to provide them with a moat, modern economic moats usually consist of some combination of superior market share, tangible assets, or regulatory advantage.
The U.K.'s biggest moat?
Today's share features all three of these benefits and offers one of the widest moats you will find in the U.K. National Grid
With that in mind, I was keen to take a look at its full-year results when they were published on Thursday.
Hidden depths
National Grid emerged from the U.K. utility privatizations of the '80s and '90s. It was listed on the London Stock Exchange in 1995 and has since grown into one of the largest companies in the FTSE 100, with a 24 billion-pound market capitalization and 14 billion pounds in annual revenues, which are split nearly equally between the company's U.K. and American businesses.
In Great Britain, National Grid is the monopoly owner and operator of the electricity (National Grid operates only the electricity transmission network in Scotland; the group doesn't own it) and gas transmission networks. It also operates the gas and electricity systems, ensuring that supply is matched to demand at all times. Finally, it owns four out of the eight regional gas distribution networks -- the networks that take gas from the transmission network to your house.
American activities
In the U.S., National Grid's activities are focused on the Northeastern states, where it has both transmission and distribution businesses. The U.S. electricity and gas markets are more heavily regulated than in the U.K., and prices are controlled and linked to inflation, providing a stable and controlled business environment -- albeit slightly less profitable than in the U.K.
National Grid's U.S. electricity transmission business covers only New York, Massachusetts, Rhode Island, New Hampshire, and Vermont but contains 13,800 km of cable -- about 90% more than the 7,300 km that makes up the entire electricity transmission network in England and Wales! This demonstrates just how large the U.S. market is -- regional licenses like those held by National Grid are still substantial businesses.
National Grid also operates gas and electricity distribution networks serving about 3.5 million customers in New York, Long Island, Massachusetts, New Hampshire, and Rhode Island.
Show me the money!
National Grid's 2011-12 results contain few surprises. Total revenue fell 3.5% to 13.8 billion pounds while profit before tax rose by 5% to 2.6 billion pounds. The company confirmed the expected 8% dividend increase, taking the total dividend for the year to 39.28 pence -- a 5.8% yield at current prices.
An 8% dividend increase is pretty impressive and is substantially above inflation. However, this could change. A 4% dividend increase is planned for the current year, and National Grid confirmed that it will be announcing a new dividend policy for future years.
The nature of this policy will depend on regulatory developments in the U.K., where utility companies are currently in the process of negotiating a new pricing regime that's intended to fund substantial upgrades to the grid. Given the vast amounts of capital expenditure needed to fund such work, National Grid's substantial dividend could increase at a slower rate over the next few years.
Debt, debt, debt
My recent article on SSE attracted some comments from Fools who were not keen on the leverage it uses to fund its capital expenditure. They pointed out that capex exceeded profits last year for SSE.
This is also true for National Grid, which spent 3.4 billion pounds on capex against pre-tax profits of 2.6 billion pounds. As a result, National Grid's net debt rose by 0.9 billion pounds to almost 20 billion pounds. Still, interest cover is a healthy 3.9 and the effective interest rate on its debt is only 5.4%, comfortably below the return on capital employed of 8.6% in the U.K. and 7.6% in the United States.
Although this level of debt is rather fearsome and represents leverage of 80% of National Grid's market value, I think the regulated and asset-intensive nature of this very large business makes it acceptable, even though I would not normally be keen.
The fact that both National Grid and SSE boast about their capex levels in the highlights at the top of their annual reports suggests that they don't think it will deter investors, either.
A Buffett buy?
National Grid's wide moat, regulated near-monopoly businesses, and strong dividend history made me think about Warren Buffett, who is known for his enthusiasm for stable, conservative businesses that generate a reliable stream of dividends.
Buffett doesn't often invest outside the U.S., but he does already have energy interests. His firm Berkshire Hathaway
(What's more, Buffett has invested more than $1 billion in building a 5% stake in Tesco, showing that he's happy to do business in the U.K. To find out how much Buffett paid for his Tesco shares, read this free report.)
One to watch
National Grid is virtually guaranteed to maintain its monopoly position in England and Wales, and its U.S. business provides attractive diversity and exposure to an alternative market. Although its profits are lower in the U.S. than in the U.K., it is closing the gap and expects to make further improvements this year.
I reckon that National Grid could just become a Buffett buy at some point, especially if its share price falls substantially over the next year as the new regulatory pricing regime is confirmed. After all, no one will ever build parallel, competing electricity and gas networks. This means that National Grid should remain a very safe place to put your money.
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