MPs think that National Grid (LSE: NG) should be broken up. Last weeks recommendation by a parliamentary committee echoes a similar call last year from energy secretary Amber Rudd.
The argument in favour of breaking up National Grid is that there are potential conflicts of interest within the firms UK operations. National Grid is responsible for organising back-up power when UK power stations cant meet demand. One way of doing this is by importing additional electricity through the interconnector with France, which National Grid also owns.
The interconnector generated an operating profit of 123m last year, up 19% on 2014. While National Grid says it has safeguards in place to prevent any conflicts of interest, critics are concerned.
I suspect shareholders will also be concerned by talk of a break-up. This supposedly dull utility stock has delivered a total return of 100% over the last five years. Thats the result of a 65% share price gain plus dividends totalling 35% of the shares value at the start of June 2011.
Should you sell?
I wouldnt rush to sell my National Grid shares. Calls for a break-up are likely to face determined opposition from the company. It may not happen.
A more realistic concern is that much of the firms share price growth during the last five years has been the result of an increase in valuation, rather than rising earnings.
The groups post-tax profits have only risen by an average of 3.7% per year since 2011. Whats really changed is that National Grid shares were trading on a P/E of about 11 in 2011. They now trade on a 2016 P/E of 16. This has pushed the firms dividend yield down from 6.2% in 2011 to 4.4% today.
Id argue that National Grids yield may become less attractive if it falls much further. I believe share price growth is now likely to slow.
A unique advantage?
Unlike other UK grocery giants, Wm Morrison Supermarkets (LSE: MRW) produces much of its own food. The groups Farmers Boy business produces fresh produce for Morrisons stores. It generated a profit of 64.9m for the year ending 1 February 2015, the most recent periodfor which accounts are available.
This vertically integrated business model might seem old fashioned, but I believe its one of Morrisons most attractive assets. Whereas Morrisons operating margin was just 2.1% last year, Farmers Boy reported a 9.1% operating margin in 2014/15. Morrisons food business clearly helps to support the firms profits, dividends and valuation.
Of course, another way of looking at things is that Morrisons could buy the same food from other suppliers for much the same price. Instead of holding on to Farmers Boy, the group could sell it and return the funds to shareholders.
Based on last years profit of 64.9m, I estimate Farmers Boy could be worth about 850m on a fairly conservative 13 times earnings multiple. This would equate to about 36p per share for shareholders around 20% of the current share price.
Should Morrisons sell? Absolutely not, in my view. I believe Farmers Boy gives ita unique advantage over its peers in terms of marketing and financial performance. This is one of the reasons why I believe theshares remain attractive for long-term buyers.
Roland Head owns shares of Wm Morrison Supermarkets. 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.