There are defensive stocks which are less affected by economic downturns than the market generally. A more elite group of defensive shares appear to operate almost independently of general economic conditions. National Grid fits firmly into the second camp.
This is largely because it has sought to make the fees it charges for energy transmission independent of the volume of energy transported (electricity or gas). As such, clearly the group hasn’t benefited from the increase in energy consumption over the winter but nor has it lost out in the past when energy demand fell on weak economic conditions.
This ensures earnings are predictable which enables high levels of debt to be serviced. Gearing is a key way utilities boost earnings as debt is cheaper than equity and so taking more on boosts returns to equity. Of course a carefully laid plan like this goes awry if earnings fail as we have seen with highly geared entities during the global financial crisis. National Grid appears to be showing that the model works for the group given its stable profits profile.
Utilities are viewed as key defensive plays because their output is seen as a necessity. This includes gas, electricity and water: products that are somewhat hard to live without. Demand does fluctuate, though, with the relative economic strength of a country as industrial and domestic use varies in different conditions.
Shutdowns by factories in addition to energy conservation, by industry and consumers, can see consumption of electricity, gas and water fall. This will affect utilities in these areas as it means lower revenue and profits. In the long-run, an expansion of demand due to population increases and industrial and commercial development is generally beneficial.
For the energy part of the mix (electricity and gas), demand is generally more responsive to cyclical economic changes than is demand for water. The price of energy also varies according to wholesale energy prices and end demand. In the UK the severest winter for a long-time saw demand jump.
Of course with National Grid largely decoupled from energy volumes this hasn’t provided a boost to profits for the group. The US business is still in the process of being decoupled, however, so there is more volatility in the earnings from that side…
