How safe is National Grid plc's dividend?

With interest rates so low on assets such as cash and bonds, I reckon many investors will be turning to defensive, high-yielding shares, perhaps investing in the stock market for the first time. A 'safety first' approach could easily lead to your attention settling on energy transmission and distribution company National Grid (LSE: NG), which operates in the UK and the US.

///>

The utility sector is well known for its cash-generating and defensive qualities. National Grid's monopoly of Britain's transmission systems adds another layer of apparent safety, although the firm's privileged position at the heart of the UK's energy infrastructure comes with the need to comply with tough regulatory demands.

A fair valuation

The firm's valuation seems fair. With the share price at 1,054p, the forward dividend yield runs around 4.3% for the year to March 2018 and City analysts following the firm expect forward earnings to cover the payout almost one-and-a-half times. Meanwhile, the forward price-to-earnings ratio sits at just under 16.

Maybe that's all we need to know, the return from the dividend will beat interest paid from many bank accounts and profits seem set to cover the cash distribution to investors. Well, it's a good start, but we need to look at the dividend's sustainability.

Profits can ebb and flow at the stroke of an accountant's pen, but what really pays the dividend is cash, and National Grid's record on cash generation is a good one. The net-cash-from-operations figures have been consistent and on a rising trend for the past five years. What's more, net cash always seems to come in above operating profits, so profits are real and backed by cash flowing into the business.

Borrowings under control

One of the uncertainties surrounding National Grid's business is the way that future regulatory demands might affect the company's ability to pay dividends to investors. Operating energy transmission and distribution systems is a capital-intensive pursuit. Governments insist on high levels of reinvestment to keep cables and gas pipes safe and efficient. In many cases, utility firms, in general, are bound to a programme of ever upgrading infrastructure in the pursuit of increasing their efficiency and reliability.

Such demands can lead to utility companies taking on more and more debt, but National Grid appears to have its borrowings under control. Net debt stood at £25.3bn at the end of the firm's trading year in March, and that compares to a debt figure of around £20.5bn five years ago. That doesn't strike me as runaway escalation of debt.

A fine balance

Last year, it cost the company £834m in interest payments to service its borrowings, £1,337m to pay dividends to investors like you and I, and £3,408m to purchase property plant and equipment. That adds up to just over £5.5bn and the firm's net cash take from operations was just over £5.3bn. The balance of demands for the firm's cash looks set to always be a fine one, but the directors seem confident that they can keep paying the company's gently rising dividend in the foreseeable future.

Minimising investment risks

All types of investing carry some risk, even income investing, so it pays to dig further into the fundamentals of firms beyond looking at dividend yields. I think National Grid is worth a few hours of your research time if you're looking for decent investments.

The Motley Fool's analysts have produced a report that highlights some of The Worst Mistakes Investors Make to help you avoid those risks.

You can get the report right now, free of charge, by clicking here.

Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.