The share prices of utility companies National Grid (LON: NG) and United Utilities (LON: UU) have beaten the FTSE 100 over the past year. They have risen by 19% and 21%, respectively, versus a gain of 14% for the index.
Although neither stock offers a high rate of earnings growth potential relative to some of their index peers, they could become more popular over the medium term. Their defensive business models and income potential could make them increasingly attractive to investors if inflation rises and recent market volatility persists.
Defensive appeal
The FTSE 100’s recent intra-day decline of 3.7% in response to the emergence of a new Covid-19 variant shows that investor sentiment can quickly change.
Currently, it remains unclear whether the new Covid-19 variant will cause a return to more widespread containment measures. However, with the pandemic continuing to threaten global growth and there being the potential for containment measures in the short run, the defensive characteristics of National Grid and United Utilities could become more appealing to a broader range of investors.
Their business models are relatively unaffected by the economic outlook. While this has arguably led to less interest in them as investments over recent months, as investors have prioritised growth amid a resurgent global economy, an increasingly ‘risk-off’ sentiment could prompt higher demand for defensive shares.
Income appeal
In addition, the income prospects offered by United Utilities and National Grid could become increasingly attractive in today’s inflationary environment. Indeed, the Bank of England predicts that CPI inflation will reach 5% by April.
Although interest rates are widely forecast to rise between now and then, holders of cash, bonds and some stocks may find that their income growth fails to match a rising price level during an era of higher inflation.
As a result, National Grid and United Utilities’ dividend growth plans could hold significant appeal. Both companies aim to grow their dividends by the same rate as CPIH, which is CPI plus owner occupiers’ housing costs. This could mean that the 4%+ prospective dividend yields they offer are maintained in real terms – even if heightened levels of inflation persist for longer than current forecasts indicate.
Sound performance
Of course, both utility companies face possible challenges in the coming years. For example, United Utilities is operating in a relatively new regulatory period that runs from 2020-2025. It contains tougher tariff requirements than the previous regulatory period that could inhibit profit growth. Meanwhile, around 40% of National Grid’s assets have typically been gas related. This could limit its growth opportunities as environmental concerns mount.
However, United Utilities’ recent results showed that it is performing in line with the new regulatory regime and is on track to meet profit and dividend forecasts. National Grid recently acquired electricity transmission network WPD and is seeking to sell gas-related assets to shift its focus towards electricity assets. They could prove to be a sound growth area, since electricity demand in the UK is forecast to double by 2050 as demand for electric vehicles rises.
Clearly, neither company’s shares may be deemed exciting by investors in comparison to other FTSE 100 stocks that offer greater growth potential. However, their solid recent performance, income appeal and defensive characteristics could make them relatively attractive for the long run.