Including dividends, a £5,000 investment in National Grid (LSE:NG.) shares made in January 2020 is now worth £6,631. That’s an average return of 5.8% a year – almost exactly in line with the FTSE 100.
Considering the stock’s often thought to be relatively safe compared to other UK shares, that looks more than respectable. And I think the outlook for the company might be reasonably positive.
Regulation
National Grid operates a regulated utilities business. And like most things in life, there are good and bad aspects to this. The obvious benefit is a lack of competition. Investors don’t have to try and stay ahead of disruptive trends – the company’s status as a legal monopoly’s protected.
The obvious downside is that the firm isn’t allowed to set its own prices. These are also regulated – by Ofgem in the UK and by a combination of State and Federal organisations in the US.
National Grid’s allowed to earn a specified return on its asset base. In the UK, that’s currently 4.25% (after inflation) and in the US it’s around 9% (before inflation).
Growth
So far, so unexciting. But I think there’s a good reason to be optimistic about the company going forward, starting with the UK review of its current allowed rate for 2026.
At the last review, National Grid’s allowed rate of return was cut from around 6% to the current 4.25%. But this was due to lower financing costs, which are part of Ofgem’s calculations.
Investors might remember though, that interest rates were 0.1% in 2021. And they’re much higher now, which might mean the company’s allowed rate could be set to increase from next year.
Nothing’s guaranteed, which is a risk with the business. But even if interest rates fall from their current levels I think shareholders might have grounds to be optimistic about the rate review in 2026.
More growth
A higher rate on its current asset base would be a welcome boost for National Grid. But it’s also worth noting that the company has plans to expand this base by making investments. Between 2026 and 2031, the firm plans to spend £35bn on UK transmission infrastructure. And it updates its asset base each year, meaning it can start earning a return on these investments quickly.
There is however, a complication. While National Grid updates its asset base annually, Ofgem reviews this each time it sets rates. So there’s a risk of the allowed return falling due to lower asset values.
Investors need to factor this into their thinking. But if the company’s careful with its capital expenditures, shareholders should benefit from the investments it makes.
Looks can be deceiving
On the face of it, National Grid looks like a business with low risk and limited growth prospects. I think that appearance might be misleading on both counts. While regulation brings risk, I think the possibility of a higher allowed rate of return from 2026 could be a big boost for the stock.
Investors should consider this carefully as a possible boost going forward.
This post was originally published on Motley Fool
