Please ensure Javascript is enabled for purposes of website accessibility

Is National Grid Stock Oversold? 1 Analyst Thinks So

By Rich Smith - Aug 1, 2017 at 11:17AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Currency fluctuations and a transformative sale make this stock an opportunity.

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

National Grid (NGG -1.52%) stock is in a rut. Down 20% over the past year, as the S&P 500 has surged ahead 14%, National Grid is underperforming the broader market by a whopping 34 percentage points. And yet, German investment banker Berenberg sees opportunity in National Grid's weakness. These shares, says Berenberg, have fallen too far, and Berenberg believes they should be bought.

Here are three reasons why.

Electric lines and towers

One analyst sees a bright future for electric and gas utility National Grid. Image source: Getty Images.

1. A transformative deal...

Let's start with the obvious: National Grid today isn't entirely the same company that it was a year ago. In December of last year, the U.S.-U.K. electricity and gas utility sold a 61% stake in its U.K. gas distribution business to a consortium led by Australian investment bank Macquarie.

This sale, valued at $17.8 billion, yielded a $7.5 billion profit for National Grid. Shareholders were further treated to a $5.42-per-share special dividend from the proceeds, and will benefit further as National Grid undertakes to use cash from the sale to buy back $1 billion worth of its own shares (reducing the share count, and boosting earnings among the shares that remain). 

On the downside, the subsidiary in question has been generating sales in the $1.4 billion to $1.7 billion range annually over the past five years, and at operating profit margins approaching 50%. Much of that revenue, and those profits, will no longer benefit National Grid.

2. a country dogged by Brexit

A second concern surrounding National Grid stock is currency exchange rates.

US Dollar to British Pound Exchange Rate Chart

US Dollar to British Pound Exchange Rate data by YCharts.

Britain's national currency, the Great Britain Pound (GBP) has been swinging wildly in value since the country announced its exit from the European Union last year. Prior to Brexit, 1 GBP bought $1.49, but by the time the currency hit its nadir in January of this year, the pound sterling had lost nearly 20% of its value, and 1 GBP bought only $1.20.

By the start of this week, the pound had recovered about half its lost value, and was trading back again at an exchange rate of 1 GBP to $1.32. But even so, that means that every pound of profit that National Grid earns in the U.K. today translates into 11.5% less profit for National Grid shareholders in the U.S. than the same pound generated as recently as last summer.

3. What Berenberg says

But here's the thing: Even in the best of times, foreign exchange rates fluctuate. From late 2007 to early 2009 -- a period that encompassed the Financial Crisis, but that came long before Brexit, the dollar gained more than 50% in value against the pound.

Brexit may make for more turbulence in the GBP:USD exchange rate, but it isn't exactly a new problem. And as for National Grid's sale of a majority stake in its U.K. gas distribution business, yes, it was a big deal. But National Grid didn't give up that stake for nothing. It got a mountain of cash in return.

In any case, the business in question accounts for less than 8% of National Grid's annual revenue. Although a big deal, as reports (requires subscription), Berenberg believes that "fundamental[ly] nothing has changed." National Grid has a slightly smaller business after the sale -- but a whole lot more cash to play with.

The most important thing: Valuing National Grid

So what's the upshot of all the above? Berenberg believes that National Grid stock has been punished too severely for changes that are not really "fundamental" to its business. And this business, according to analysts who follow National Grid stock, is still pretty good.

Post-divestiture, the consensus among analysts polled by S&P Global Market Intelligence is that National Grid will probably earn about $2.8 billion in net profit next year. Weighed against the stock's $42.3 billion market capitalization, that works out to a forward price-to-earnings ratio of 15.1 -- which doesn't seem terribly expensive on its face.

In return for paying this price (says S&P Global), investors can look forward to steady dividends yielding 5.2% and earnings growing at about 3% per year. (Or more -- National Grid is targeting 5% to 7% growth in regulated assets alone. With rate hikes, profits might grow even more than that.)

Between the dividend and the potential for stronger-than-expected earnings growth, I'd say that while National Grid isn't an obvious bargain, it is at least a fairly priced stock.

Rich Smith has no position in any stocks mentioned. The Motley Fool owns shares of and recommends National Grid. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

National Grid plc Stock Quote
National Grid plc
$68.55 (-1.52%) $-1.06

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/07/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.