Image source: National Grid plc
National Grid (LSE: NG) shares have dipped 3% from their 23 April post-rights issue high of £11.03. This seven-for-24 exchange occurred on 10 June last year and secured £7bn in new funding.
That said, the stock is still 22% higher than the £8.75 low it hit since that event.
So, does the dip represent a pullback closer to the stock’s fair value? Or does it mean a better opportunity to buy an already undervalued stock at an even cheaper price?
I took a deep dive into the business and ran the key numbers to find out.
The business
The firm’s 15 May full fiscal-year 2024/25 results revealed that operating profit increased 10% year on year to £4.934bn. Profit before tax jumped 20% to £3.65bn, while earnings per share (EPS) increased 8% to 60p.
Meanwhile, record capital investment of around £10bn was made – an increase of 20% on the previous year. This was in line with the firm’s government-mandated plans to invest around £60bn in power infrastructure over five years.
These investment plans are a significant risk, in my view. On the one hand, they could be fully- or partly-funded through further rights issues, but this risks shareholder value dilution.
On the other, they could just add to the firm’s substantial debt burden. More specifically, it has a net debt-to-equity ratio of 5.9 compared to the 3 or less considered healthy.
That said, analysts forecast its earnings will increase 11.1% a year to the end of fiscal-year 2027/28. This is the key driver for any firm’s share price (and dividends) over the long run.
How does the share valuation look?
On the key price-to-sales ratio, National Grid’s 2.8 figure is very overvalued against its competitors’ average of 1.1. These comprise E.ON at 0.5, Engie at 0.6, Enel at 1, and Iberdrola at 2.3.
It also looks very overvalued at a price-to-earnings ratio of 18.2 compared to the 13.7 average of its peer group.
However, on the price-to-book ratio it looks undervalued at 1.4 against its competitors’ average of 2.
I ran a discounted cash flow analysis using other analysts’ figures and my own to get to the bottom of the valuation. This highlights where any firm’s share price should be, based on cash flow forecasts for the underlying business.
In National Grid’s case, the analysis shows the shares are 5% undervalued – almost the same as the dip. Therefore, the ‘fair value’ for the stock is £11.26.
So will I buy?
I have mainly focused on shares with a 7%+ dividend yield since I turned 50. However, I do occasionally buy growth stocks geared to share price gains.
That said, my minimum requirement for these is that they must be at least 30% underpriced to their fair value.
One reason for this is that anything less could be largely wiped out in volatile markets. The other is that there are plenty of other FTSE 100 and FTSE 250 stocks that are at least as undervalued as this.
Consequently, I will not be buying National Grid as a growth stock prospect. And with its 4.5% yield, I will not be buying it as a dividend stock either.
