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On a superficial level, it is easy to understand why National Network (LSE:NG) is a popular choice with many income investors. National Grid stock offers a 6.5% dividend yield, for starters. That means that for every £10,000 I invest in them now, I expect to earn £650 a year in dividends.
That dividend has increased annually for years. Over the past three years, for example, the annual dividend per share has increased 19%. In my opinion, this is a substantial increase.
Business with few competitors and strong demand
But any smart income investor knows that just looking at dividend history isn't enough.
After all, dividends are never guaranteed. That is why it is important to look at the fountain of dividends. How is the company making money? Can he continue to do so, based on what we currently know?
Once again, National Grid stock has some promising features.
After all, while energy sources may change, the need to transport energy across a grid will remain for decades to come. National Grid's existing infrastructure is expensive and difficult, if not impossible, to replicate. Realistically, I hope no one even tries to do that, although companies can try to compete against select parts of it.
National Grid is the kind of energy monopoly that billionaire investor Warren Buffett tends to like. In fact, Buffett's company Berkshire Hathaway it actually owns Northern Powergrid, a regional network and provider focused on the north of England.
So why don't I have any interest in owning National Grid shares?
High debt and large spending requirements
In one word, the answer is “debt.” Lots.
National Grid started last year with £41bn of net debt (basically debt that remains after assets are taken into account). At the end of the year, that figure was £43.6bn.
This continues a long period of rising net debt. A decade ago it was £21.2bn. That means that, in the decade ending last year, the company's already substantial net debt more than doubled.
Because? Managing and maintaining a power grid is an expensive business that requires high capital expenditures. I hope it stays the same.
The flip side of that expense is that it allows National Grid to run its business and make money. But as with many regulated utilities, prices are also set by the government or regulator, not just the market.
Why won't I buy the shares?
Do shareholders care? They're earning a handsome dividend and National Grid shares are up 15% in the last five years.
But a growing dividend and increasing net debt often can't survive forever. One way to reduce debt is to spend less money on paying dividends and more on paying off loans.
National Grid has not done that. Instead, it issued millions of new shares this month as part of a rights issue aimed at raising £7bn in capital.
This should strengthen the balance sheet for now.
But while I see it as prudent, I think it shows the reason why I have no interest in owning National Grid shares: I think the dividend is at risk if the company's net debt continues to grow. A rights issue buys time, but it has not resolved that fundamental challenge.
