EUR 850.00 For Business Accounts Only

Morningstar | National Grid's Half-Year Results in Line With Our Full-Year Expectations; Shares Overvalued

We reiterate our fair value estimate of GBX 780 per share after National Grid published half-year EPS results in line with consensus and our full-year expectations. We maintain our no-moat and stable trend ratings. The shares appear overvalued.

Underlying operating profit decreased 6% in the first half to GBP 1,285 million, slightly below consensus expectations though roughly in line with the 6.7% decline that we expect for the full year. Underlying profit before tax decreased 4% to GBP 0.8 billion, 5% below consensus. Underlying EPS grew 6% to GBX 19.70, in line with consensus expectations thanks to U.S. tax reform and a positive one-off on financial costs.

On the negative side, U.K. gas transmission's operating profit decreased 37% to GBP 91 million, in line with our full-year 36% estimate, due to the return of allowances received in prior years, as planned. In the United States, underlying operating profit decreased 17% due to the impact of U.S. tax reform and GBP 56 million of storm costs. This is above our 4% decline that we assume for the full year due to the storm costs--to be ultimately passed through to customers--and the second-half weighting of profits. On the positive side, U.K. electricity transmission's EBIT grew 3% to GBP 556 million, in line with our full-year estimate. Altogether, we do not plan to change our full-year estimates based on the results.

The group announced that it will sell its remaining 39% stake in Cadent, the U.K. gas distribution business, by exercising its put option. Cash proceeds will amount to GBP 2 billion and the sale will be completed in June 2019. The sale will have no impact on our valuation since we value the asset at its book value of GBP 2.1 billion. However, we calculate that it will be dilutive by around 5% on the bottom line. This disposal reflects narrowing financial headroom as the group must fund hefty investments and dividends. We forecast net debt/EBITDA to increase from 4.6 times in 2018 to 5.7 in 2022.

The group has launched a cost-efficiency program in the United Kingdom expected to generate annual operating cost savings of GBP 50 million in 2020 and a total of GBP 100 million from 2021 onwards; this entailed an exceptional restructuring charge of GBP 127 million in the first half. Typically for regulated utilities, a large part of costs savings must be given back to customers. Besides, during the conference call, the management highlighted that this program will help to underpin its outperformance target of 200-300 basis points in the U.K. networks through the end of current regulatory regime RIIO-T1 in 2021, in line with our estimates.

In the U.S., National Grid faces an ongoing conflict with unions in Massachusetts over negotiations on new healthcare and pension plans. As no agreement was reached before the contracts' expiration, the group has had to implement contingency workforce plans since the end of June. That drove additional costs of GBP 97 million, or more than GBP 30 million per month. These additional costs are classified as exceptional.