US Edition National Grid
564½p +1½
Questor says BUY
One market commentator called Monday's update from National Grid's "rather bland". Questor disagrees – the update confirmed the safety of this investment and that is exciting news.
The main reason to hold utility stocks is their dividend – and the shares are yielding a chunky 6.8pc at the moment. With interest rates so low, this remains a good investment for income seekers. Indeed, the group has a said that it will grow its dividend by 8pc up to 2012, so investors can be confident about medium-term income growth too.
The company is also benefiting from falling interest costs, bolstering its financial position. It has refinanced most of the debt that is due this year, so Questor remains unperturbed about the group's debt profile.
National Grid said that it continues to trade in line with management expectations – and it still expected a "strong" performance over all of its businesses. It expects to deliver an improved performance in the full year, with its electricity distribution and generation division achieving a substantial improvement in profitability and its transmission business seeing continued good momentum.
The company's business is split roughly 50-50 between the UK and US. Most of the investment is in the UK, but there will also be some in the US. The United States has a creaking infrastructure – so offer great opportunities. In January, the American Society of Civil Engineers gave a 'D' grade to US infrastructure as whole, arguing that the lack of investment for endangering future prosperity.
The company also has a "natural debt hedge"' which protects it from movements in currency markets because of the split of its debt in pound and dollars. Essentially, an increase in debt repayments caused by currency movements will be made up by a boost in earnings.
When Questor last updated on National Grid, it was noted that there is some work to be done with the company's US assets, and the group was renegotiating contracts on underperforming assets. The company has recently renegotiated two contracts in the US for allowed return on its assets. Its New York gas business is now allowed a base return on equity of 10.2pc but its New Hampshire gas rate case was slightly disappointing.
The group has been allowed a return on its regulated assets in the state of 9.54pc, but the group is in discussions with New Hampshire Public Utilities Commission about this out-of-kilter decision. Its Rhode Island contract, which was renegotiated last year, for example, allows for a 10.5pc return on its assets.
About 95pc of the company's earnings are regulated, but the group has unregulated exposure as well that has good upside potential. The group's liquefied natural gas (LNG) terminal on the Isle of Grain in Kent is one such asset, where it has long-term contracts already in place. Eventually, the terminal is expected to handle 20pc of the UK's imported gas.
Immediately following the trading update, Clive Hawkins, an analysts at Standard & Poor's Equity Research, slapped a strong buy rating on the shares with a 631p-a-share target, which is some 11pc above the current share price. The shares are now trading on a March 2010 earnings multiple of 9.8 and remain a buy for their solid, safe dividend.
Pearson
679p +73p
Questor says BUY
Questor recommended buying shares in education publisher Pearson on March 9 at 653½p. The shares then started a slow and painful move downwards, which was perplexing because their education operations made the business relatively defensive and the shares have a solid dividend yield as support. Even after yesterday's jump in the share price, Pearson shares are yielding a respectable 5.2pc.
Its first-half results were better than expected. Pre-tax profits for the six months came in at £62m compared with £55m in the equivalent period of last year. Trading is ahead of expectations and the group guidance is for earnings per share to be "at or above" last year's 57.7p. This is despite a currency deterioration since guidance was last given. In effect, this means that the company is looking for a 3p or 4p increase in earnings once currency effects are stripped out. This shows operational strength.
The FT Group, which contributes about 3pc of revenues, is performing well given the weak advertising backdrop, as is Pearson's children's book group Penguin.
In a reassuring move, the company hiked its interim dividend by 3.4pc to 12.2p. The shares trade ex-dividend on August 19, so new investors can buy the shares now and lock in this payment, which will be made on September 18. This gives a near-term yield of almost 2pc.
The shares are trading on December 2009 earnings multiple of 12 based on current forecasts, however, earnings estimates are likely to rise following this statement. If the consensus view is raised to 57.7p a share, the lower point of the company's guidance, then the shares will be trading on a forward multiple of 11.8 times.
This does not seem high considering the defensive nature of its education portfolio, which has proved itself in the first half. Credit Suisse described the company as one of its "core fallen angels". Shares in Pearson, which are now back above their initial recommendation price, remain a buy.