If inflation soars, can the National Grid dividend keep up?

With oil prices rising and a high level of geopolitical uncertainty, many people are nervously eyeing the inflation rate. Higher inflation makes life even more expensive. That helps explain the attraction for many investors of power network operator National Grid (LSE: NG), which is aiming to grow its dividend per share each year at least in line with a common measure of inflation.

So could it make an attractive investment for my portfolio?

National Gridâs inflation-matching goal is clear

When it can, I believe National Grid will deliver on its stated dividend policy of aiming to grow the payout at least in line with inflation.

Partly that is because I see this as a key plank of the utilityâs investment case. So the board will likely be keen to deliver on its dividend policy.

But there is a practical factor at play too that helps to support the National Grid dividend.

As a regulated utility, National Grid has pricing power. Regulators typically build inflation into their assumptions when setting operating conditions for a utility such as National Grid.

So, management is likely to want to keep growing the National Grid dividend â and it has pricing power that can help it in that regard.

Selling prices are only one part of the equation

However, that is not the whole story.

While National Grid may be able to pass some cost increases onto its customers in the form of higher prices, inflation is still a risk to its profit margins if it cannot pass them on fully.

An even bigger risk, in my view, is the cost of running and maintaining a series of sprawling power distribution networks.

That would be the case at any time but it has been especially obvious in recent years, as patterns of energy generation and consumption have shifted.

Further dividend cuts are possible

Reshaping National Gridâs networks has partly been funded by borrowing. The companyâs net debt grew in its most recently reported six-month period and now stands at Â£42bn.

That is equivalent to around two-thirds of its Â£63bn market capitalisation and makes me uncomfortable.

Servicing debt takes money, as does repaying it. Interest rates now look like they could rise repeatedly over coming months, so issuing new debt could become costlier.

On top of that, the firmâs large debt load and high capital expenditure requirements saw it cut its dividend per share substantially last year.

Although it aims to grow the payout per share in line inflation, National Grid has not always delivered on that goal — and that is a risk I see for future dividends, too.

The economics of a monopoly or near monopoly can be attractive. I expect National Grid to remain highly cash generative in future.

However, I think there are more reliable dividend payers elsewhere in the stock market, so I have no plans to buy this particular share.

The post If inflation soars, can the National Grid dividend keep up? appeared first on The Motley Fool UK.

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C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended National Grid Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.