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Time to switch to National Grid?

Last updated: 07:51 25 Jun 2009 EDT, First published: 06:51 25 Jun 2009 EDT

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The recent falls mean the shares of National Grid are yielding over 7% and with a dividend cover of 1.5 the payout looks relatively safe. Furthermore, the group has announced a guaranteed 8% annual rise in its dividend payments all the way to 2012.

 



As can be seen from the above chart of the FTSE 100 the index has moved lower after breaking key support at 4300 last week.

Investors risk appetite appears to have lost momentum as a late frost has stemmed the green shoots of recovery that have been sprouting recently. Earlier in the week the S&P suffered its worst one day fall for two months and closed below its 50 and 200 day moving averages, which put it in negative territory for the calendar year.

The VIX volatility index, which is a popular measure of volatility and confidence in the US economy has moved back up above the 30 level and quantifies the recent apprehension. The outperformance of defensive stocks in recent days also confirms this as investors have rotated funds out of beta companies into these lower risk equities.

Technical analysis of the above chart highlights the break below the recent channel and a fresh short term low for the blue chip index, which suggests a more bearish view for the weeks ahead. The relative strength index (RSI) has been in a downward trend since early May and has further to fall before reaching official oversold territory.  

However, the US markets are yet to breach their comparable trading ranges of 8200 on the DOW and 878 on the S&P, which could provide support to our market.

The next major support level for the FTSE is seen at 4000. Although there is a large amount of cash waiting on the sidelines from both funds and private investors and as many believe the economy is through the worst these fresh funds are likely to start feeding into the market in anticipation of this level, which may prevent it from going that low.

In summary, I believe that 4300 was a significant level and with the RSI trending lower it suggests there could be further weakness to come in the short term. However, US markets remain relatively resilient and in the light of funds waiting to enter the market I am reluctant to open outright shorts at these levels.

I do believe that traders should consider buying the index on further weakness or opening a long FTSE / short DOW pairs trade, as I believe this divergence will unwind in coming weeks.

As a result of recent rotation between sectors I have been focusing on well capitalised stocks that pay a healthy dividend yield, as these are likely to attract money coming into the market at these depressed levels.

National Grid (epic: NG.) is one of the world’s largest utility companies, delivering gas and electric across Great Britain and North Eastern America.

The recent falls mean the shares are yielding over 7% and with a dividend cover of 1.5 the payout looks relatively safe. Furthermore, the group has announced a guaranteed 8% annual rise in its dividend payments all the way to 2012.

However, the company is more than just an income play. Final results released on the 14th May showed a 12% rise in full year earnings before interest, taxes and exceptional charges in the US. EBIT for the year ended March 31st 2009 totaled £2.915 billion compared to £2.595 billion the previous year and above analysts expectations of £2.80 billion.

The outlook is also positive for all of the groups divisions. The US represents around 50% of the business and with plans for the US government to subsidise upgrades of the power transmission networks to make them more efficient, it is likely that National Grid will increase its asset base over there in the next few years.

The company’s debt profile has been of great concern to investors and has weighed heavily on the shares recently. Net debt for 2009 stands at around £22.7 billion and Moody’s, which is one of the worlds largest credit rating agencies, recently lowered their credit rating on the group to negative, which sparked fears that a rights issue was needed and this has deterred many investors.

The group is expected to invest £3.4 billion this year to support its UK investment program, but is only funding £1.1 billion of this with fresh debt. It also needs to refinance £1.4 billion of historic debt this year and around 70% of this has already been secured. Finance director, Steve Lucas is confident the remainder will be raised without concern, as the company has good earnings visibility and access to credit is improving. The group is also extremely cash generative with about 75% of the group’s investments generating cash within their first year.

In light of this recent financing many analysts believe Moody’s may remove their negative rating shortly and this could act as a catalyst to the shares, as it did with International Power and Scottish and Southern earlier in the year.

The shares are boasting an impressive and escalating dividend policy and are currently trading on an attractive forward earnings of 9.3x. Interestingly on the 5th June Crescent Holdings, which is part of Saudi Arabian investment company Olayan took a 4.39% stake in the company.



As can be seen from the above chart of National Grid the shares are down around 13% from the recent highs of 616p experienced last month.

The shares found support at 530p earlier this month, which was encouragingly above the lows of 510p seen in April and with the financing in place and recently announced dividend policy I cannot see much further downside for the shares in the medium term.

The oscillators are also starting to suggest that there could be further upside to come, with the moving average convergence divergence (MACD) histogram stepping higher and the moving averages rolling over and starting to cross. The RSI is also rising, which suggests there is some momentum behind the recent strength.

If we combine the strong fundamental and technical analysis discussed for National Grid, with the apparent rotation into more defensive stocks, I believe the shares offer good upside potential at current levels.

At the time of writing the share price is 538.5p and my short term opinion is positive. Near term targets are seen at 558.5p, 575p and 610p, with a stop loss marginally below the April lows at 506.25p.



Mark Allen is Head of derivatives at Simple Investments Stockbrokers. The writer does not hold a position in National Grid. The material in this report has come from Simply Charts and National Grid’s corporate website. 

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