An undervalued FTSE 100 income stock with 28% upside

A “buy” upgrade in support of National Grid (LSE:NG.) as a “top-tier growth utility” has presented a different side to a defensive stock best known by investors for its inflation-linked dividend.

Jefferies believes the stock market is overlooking the game-changing impact of the UK's plan to overhaul its transmission grid to facilitate more offshore wind connections.

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Together with momentum in the United States, the City bank expects the next 12 to 24 months to dramatically increase visibility on National Grid’s “highly compelling” investment case of 10% a year regulated asset base growth up to 2030.

It notes that the 5.4% yielding shares currently trade at 14.3 times forecast 2024-25 earnings, a 5%-10% discount to the 10-year average.

The bank thinks this gap is unjustified and believes National Grid’s decade-high growth outlook justifies the FTSE 100 stalwart being on a multiple of 18 times. Its upgraded price target to 1,330p represents a 28% upside on Friday’s price and yielding dividend income of 4.5%.

Outperformance on costs and performance incentives means the bank’s upside case for shares is 41% higher to 1,470p, falling to 850p in a more pessimistic scenario.

As well as support in the City, we recently included the electricity transmission and distribution business in interactive investor’s list of 10 stocks for a £10,000 annual income in 2024.

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The dividend is benchmarked against the increase in average annual CPI plus housing costs, meaning the payment is protected in real terms. For 2022-23, this meant an overall rise of 8.77% to 55.44p a share.

National Grid had £14 billion of distributable reserves at the end of March, which it has pointed out is sufficient to cover more than five years of forecast group dividends.

When the company last updated the market in November, it said capital investment in its regulated networks reached a record £3.5 billion in the half year amid spending on 17 major onshore and offshore transmission projects in the UK.

In the US, where its gas and electricity businesses supply energy directly to customers, it is progressing a number of major transmission projects to unlock renewable generation and upgrade infrastructure.

The support of Jefferies comes after its analysts reviewed National Grid’s capital expenditure upgrade cycle, arguing that it is on track to be a top-ranked regulated growth utility.

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The driving force is the UK government's plan to increase offshore wind capacity to 50 GW by 2030, which Jefferies estimates will require a substantial expansion of the electricity transmission grid equivalent to £15-£19 billion of capital expenditure.

New York growth is underpinned by a 15–20-year pipe replacement programme while capital expenditure in Massachusetts is expected to increase to support the state's climate ambitions.

The bank believes the balance sheet impact of the spending is manageable, noting the potential for a rotation of £4-5 billion of non-regulated assets to help fund regulated growth.

Risks to the “buy” case focus on the unprecedented scale of the capital expenditure programme and political events. However, the bank added: “We think general election uncertainty is priced in. The Labour Party is supportive of grid investments and might be good for the thesis if it pushes hard on grid build-out.”