National Grid Hit a Few Stumbling Blocks in Its First Half

Whenever a company is in transition like National Grid (NGG +0.53%) is, it's bound to run into a few hurdles along the way. In its most recent half-year earnings report, the electricity and gas utility reported some one-time impacts as it looked to overhaul its U.K. business, and renegotiated some contracts with its U.S. subsidiaries. Despite these charges, management believes it is on the right track, and continued to invest in one of its largest growth opportunities: interconnector lines between continental Europe and the U.K. 

Here's a brief look at National Grid's most recent results, and a breakdown of what investors should take away from the report.

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National Grid's earnings: The raw numbers

DATA SOURCE: NATIONAL GRID EARNINGS RELEASE. EPS = EARNINGS PER SHARE.
*NATIONAL GRID RESULTS ARE REPORTED IN BRITISH POUNDS AND WERE CONVERTED TO U.S. DOLLARS USING NATIONAL GRID'S ACCOUNTING STANDARD, WHICH IS A WEIGHTED AVERAGE EXCHANGE RATE FOR THE RESPECTIVE REPORTING PERIOD. FOR H2 2018, THE EXCHANGE RATE WAS 1 POUND = $1.31. FOR H2 2017, THE EXCHANGE RATE WAS 1 POUND = $1.31.
**1 U.S. ADR = 5 COMMON SHARES OF NGG.

When American investors take a look at National Grid's results, they typically have to take these numbers with a grain of salt because of fluctuations in the relative values of dollars and pounds. Interestingly, though, this time, the company's weighted average foreign exchange rate for the two reported periods was the same. 

For a utility business that is typically expected to be slow and steady, that 36% decrease in after-tax profit is jarring. Management noted, though, that it took about 270 million pounds in one-time charges related to a restructuring of its U.K. transmission assets, a work contingency plan with its Massachusetts Gas business, and higher than usual storm repair costs. Factoring out these charges, National Grid's earnings per share were up 6% to 19.7 pence ($1.29 per US ADR).

Because of the charges incurred by its U.S. business, earnings for that segment fell significantly from H1 2017. The company said, however, that most of those storm-related charges could be recovered through rate adjustments, and that it expects results for the remainder of the year will more than compensate for them. (Note: National Grid changed its reporting from adjusted operating profit in 2017 to underlying operating profit. So the numbers in this half-year report can't be compared in a perfectly apples-to-apples way to those in the 2017 report.)

Data source: National Grid. Chart by author. NATIONAL GRID RESULTS ARE REPORTED IN BRITISH POUNDS, AND WERE CONVERTED TO U.S. DOLLARS USING NATIONAL GRID'S ACCOUNTING STANDARD, WHICH IS A WEIGHTED AVERAGE EXCHANGE RATE FOR THE RESPECTIVE REPORTING PERIOD. FOR H2 2018, THE EXCHANGE RATE WAS 1 POUND = $1.31. FOR H2 2017, THE EXCHANGE RATE WAS 1 POUND = $1.31. 

What happened this quarter?

• Management elected to exercise its option to sell its remaining 39% stake in Cadent, the U.K. gas distribution business that National Grid spun off in 2017. 
• Management gave the green light to start construction on the Viking Link Interconnector high-voltage electric line between Great Britain and Denmark. The 850 million pound project is expected to go live in 2023. When it's completed, National Grid will have four international transmission interconnector lines, which it expects to generate 250 million pounds in EBITDA annually by the mid-2020s.
• Management initiated a cost efficiency program that it expects will generate savings of 50 million pounds starting in 2020 and 100 million pounds each year afterward.
• National Grid also announced a full refresh of rates for its distribution businesses, which will help to fund the $1.5 billion in spending this half year in the U.S. alone. 

What management had to say

In a press release, CEO John Pettigrew highlighted the company's  major capital projects in the U.K. and the continued growth of its U.S. regulated business.

We have continued to make strong operational progress in the first six months while maintaining excellent levels of safety and reliability. Investment in our networks increased to 2.1 billion pounds, including further progress on our three major interconnector projects. In the U.K., we are implementing a cost efficiency and restructuring program to ensure that we continue to drive outperformance for customers and shareholders. In the U.S., we have completed a full refresh of our rate plans so that all our distribution businesses are now operating under new rates, a major milestone which will support our continued growth. We continue to seek a fair settlement on union negotiations in Massachusetts.

Strategically, we have made good progress with the decision to exercise options for the sale of our remaining 39% share in Cadent and the final investment decision on the Viking interconnector. Looking forward, National Grid is well positioned for the ongoing energy transition and we are on track to achieve asset growth at the top end of our 5%-7% range in the medium term.

You can read a full transcript of National Grid's conference call here. 

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Looking forward

National Grid has been in flux for the past year or so, since it spun off its gas distribution business and began investing the proceeds in new projects. So while the company's reported numbers are down, this is more a result of management's decisions to go in a different direction than of any degradation of performance in its existing asset base.

This is a company with a lot of irons in the growth fire. Its investments in interconnector transmission lines will significantly boost its bottom line, over and above the typical gains from expanding its asset base in the U.S. and U.K. Keep in mind, though, that some of these projects aren't slated to go live for another five years, so investors looking to benefit from those growth catalysts will need to be patient.