Sunday, October 15, 2017

A current AIM International Fund Holding: National Grid PLC (NGG) by Thomas Dietz "It's time for AIM to get off the grid"

National Grid PLC (NGG, $62.71): “Get Rid of the Grid”
By: Thomas Dietz, AIM Student at Marquette University



Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.

Summary

National Grid PLC (NYSE:NGG) provides gas and electricity transmission in the United Kingdom and electricity transmission in the Northeastern United States.  NGG is headquartered in Warwick, UK.

• NGG is emerging from the sale of a 61% stake in their UK gas segment. 

• This has transitioned NGG from a roughly 50/50 revenue distribution between the UK and US to 33% British and 67% American.

• The rationale is to shift more attention and resources to the higher growth US segment of the business.

• This is a potentially risky play, as the US segment sees significantly lower ROE of 8.2% vs 13.1% in the UK.

Key points

Utilities in both the UK and the US are subject to heavy regulation and government oversight.  Both governments dictate how much the company can spend on capital expenditures each year and how profitable they can be in terms of ROE.  The decision for the UK based company to move most of its focus across the Atlantic was not made lightly, but it has already seen issues arise.  NGG must regularly negotiate what its profitability levels can be with New York's Public Service Commision, and it has underperformed other Northeastern US competitors.  ConEd and KEDNY both negotiated for a 9.0% ROE while NGG was only able to procure a rate of 8.25%. 

Utilities as sector can be used as a bond proxy (in some situations) during times when yields are especially low.  This has worked in NGG's favor over the past few years as yield hunters have been forced to broaden their scope to find returns.  However, there is trouble on both the sector front and the bond front.  In the past twelve months, NGG has fallen 11.9% compared to the utility sector as a whole, likely from the outcome of the UK/US rearrangement.  This had made NGG less appealing to utility investors. Additionally, the 10bp sell off in the bond market was correlated to utilities slightly underperforming the S&P as a whole.  The underperformance of utilities was at least partially influenced by the outflow of investment from utilities back into fixed income.


What has the stock done lately?

It has been a tumultuous summer for NGG.  2017 started off as one of the best years in NGG's history, but from May to July, the stock fell a massive 18.1%.  The stock started to slowly make back its losses, but the past week erased most of those gains, and it is now only 5% above its 6 month historic low. 

Past Year Performance: YoY the stock has only increased 0.1%.  The 52 week high-low is $73.24 to $55.20.  On price performance alone, the past year has been the most volatile of the last five years. 

1 Year Stock Chart vs. Benchmark from FactSet
Source: FactSet

My Takeaway


The factors that made NGG attractive over the past five years have waned.  Over half a decade of low rates has made NGG and their ~5% annual dividend appealing, but the tide seems to be finally turning.  Sale of the high ROE British gas segment, failure to negotiate better contracts in with the state of NY, and a rising rate environment together have soured what used to be a strong performer.  Furthermore, the high volatility is unappealing in a sector that is renowned for low, slow growth and high dividends in developed countries.  I therefore believe it is time for the AIM international fund to part ways with NGG.


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