Jefferies downgrades National Grid to 'hold'

Jefferies said the relative safety of National Grid's regulated networks had been a key driver of its stock outperformance amid macro-volatility over the past twelve months.

However, the broker now expects affordability-driven regulatory scrutiny, rising real yields, and a lack of balance sheet headroom to curtail further share price upside going forward.

"We see risk rising in the utilities sector as it strives to find the balance between investment and consumer affordability crisis. We estimate that utility bills as a proportion of disposable income is on track to be the highest (~10%) it's been since the 1970s. This is a challenging backdrop for NG given circa 55% of its regulated asset base will go through a tariff review over the next two years. Just yesterday, UK regulator Ofgem released their draft determination for electricity distribution grids (~20% of NG's asset base), cutting returns from 4.4% to 3.26% (CPIH basis) in a bid to reduce domestic bills," noted Jefferies.

The analysts also noted that with recent rate hikes by central banks in both the UK and the US, real rates were now on the rise, which they see as a headwind for National Grid's long-duration assets.

"More importantly, real rates are driving up discount rates at a time when real regulated returns on NG's grid assets are either flat or expected to decline. In the current environment, the return spread is likely to remain under pressure, which will be an overhang for the stock," said Jefferies.

"We have undertaken a broad refresh of our model, updating it for recent results, scope changes and mark-to-market effects. Overall, our price target of 1070p is ~1% higher than previous PT. In terms of FY23-26 EPS, our forecasts are -2.4%/+3.7%/+2.7%/+1.4% relative to Visible Alpha consensus. The stock currently trades on an EV/RCV of ~1.4x which is in line with its five-year average. We estimate NG's FY23/24 P/E to be 14.4x, which compares with the utility sector P/E of 16.8x and NG's 3-year average P/E of 15.0x. NG's FY23/24 D/Y is in line with sector average at 5%."

Reporting by Iain Gilbert at Sharecast.com