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Juicy 6.4% Yield Could Make SSE PLC A Buy

One year ago, I described energy company SSE (LSE: SSE) (NASDAQOTH: SSEZY.US) as a “plodding ruminant redeemed by its tasty yield”, but in recent months the sheep has been savaged. The big bad wolf came in the unlikely guise of Labour leader Ed Miliband, whose populist plan to freeze home energy prices blew utility company stocks down. SSE’s share price has dropped over 20% from its 12-month high of 1,676p, to today’s price of 1,316p.

This isn’t just a short-term dip, SSP has underperformed for some time. It has grown just 24% over the past five years, against more than 60% for the FTSE 100 as a whole. But it does have one big fat number in its favour, its 6.4% yield, second highest on the FTSE 100 after volatile mining stock Fresnillo. Some will see this as a green light, others will view it as a flashing red warning signal. Naturally, it’s both.

Heat is on for Kelvin

Red lights abound with this stock right now. Adjusted profit before tax fell 11.7% to £354 million in the six months to 30 September. Adjusted earnings per share fell 17.4% to 29.4p. Chairman Lord Smith of Kelvin noted that “energy market conditions generally have been difficult for some time”, then spent most of his time trying to justify its “unfortunate” 8.2% hike in gas and electricity prices, while blathering on about “responsible companies which are committed to this country, committed to their customers and committed to financial discipline”. When management starts talking like politicians, you know they’re in trouble.

Worryingly, SSE’s retail arm posted an operating loss of £115 million due to “higher wholesale gas, distribution, environmental and social costs”, although its networks and wholesale businesses still turned a profit. The good news for investors was that SSE lifted the interim dividend 3.2% to 26p a share. Management said it plans to deliver full-year dividend increases above RPI inflation in 2013/14 and the years after. This is particularly welcome, given Miliband’s accusation that SSE has a “dividend obsession”. SSE rightly replied that “our dividend policy is the reason shareholders choose to invest in SSE”. But is this enough?

Buy now, and you’ll soon get 6.9%

Prime Minister David Cameron’s panicky decision to ease the burden of green costs will help a little, but SSE still needs higher prices to drive future earnings growth. The threat of that price freeze will linger over the stock until at least the May 2015 election, and beyond, if Miliband wins.

Credit Suisse still expects SSE to ‘outperform’ from today’s lows and sets a target price of 1700p. JP Morgan and Deutsche Bank have pulled up at those red warning lights. Personally, I’m with Credit Suisse. I like buying good companies when everybody else hates them. The valuation is undemanding at 11 times earnings. Forecast earnings per share growth may be flat in 2014, but could hit 7% in 2014, lifting that yield to 6.9%. If you’re looking for long-term income, this electric sheep still has plenty of zap.

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> Harvey doesn't own shares in SSE or any other company mentioned in this article