3-Point Checklist: Should You Buy SSE PLC Or Centrica PLC?

Does Centrica PLC (LON:CNA) have the edge over SSE PLC (LON:SSE), following its recent dividend cut?

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Centrica (LSE: CNA) hit the headlines recently, after new boss Iain Conn decided to make his mark on the firm with a 30% dividend cut.

The question for investors in Centrica’s UK peer, SSE (LSE: SSE) is whether SSE is likely to make a similar cut when the Scottish firm reports in its full-year results in May.

In this article, I’ll look at this issue and compare the two firms more generally: which is the better buy for value and income investors today?

1. Yield

Utility stocks are mainly held for their reliable incomes. How do Centrica and SSE compare?

Dividend

Centrica

SSE

Trailing yield

5.6%

5.7%

2015 forecast yield

5.4%

5.9%

2016 forecast yield

5.4%

6.1%

SSE comes out ahead, assuming the firm’s payout doesn’t get cut; how likely is a cut?

SSE’s dividend is expected to be covered by earnings 1.3 times this year. At Centrica’s new, reduced, payout level, the firm’s dividend is covered 1.38 times by earnings.

On this basis, SSE could scrape through without a cut.

2. Valuation

How are Centrica and SSE valued, based on trailing and forecast earnings?

Year

Centrica

SSE

Trailing P/E

12.6

12.0

2015 forecast P/E

13.0

12.7

2016 forecast P/E

12.9

13.1

In my view, shares in both firms are valued quite fairly at the moment: I’d expect utility stocks to trade on a lower multiple than the current FTSE 100 average P/E of 16, due to their income focus and limited growth potential.

3. Operating margin

Are SSE and Centrica equally profitable?

Using each firm’s adjusted operating profit margin for the last twelve months as a guide, there’s little difference: Centrica’s operating margin is 5.9%, while SSE’s is 5.7%.

This suggests that both firms have similar cost structures and profit margins, as you’d expect from utilities.

Today’s best buy?

Centrica and SSE appear to be very evenly matched. However, that could change later this year, as the outcome of the general election could alter the outlook for both firms.

Any changes may not be felt equally by these two companies: whereas SSE is a big player in the renewable power market, Centrica has significant North Sea oil and gas production. Centrica also has a US business, but lacks the networks business that provides a stable part of SSE’s earnings.

Ultimately, I suspect that any changes will be relatively modest and gradual: neither of the main political parties seems likely to announce a dramatic change in energy policy.

Personally, I’d be happy to buy and hold shares in either company at today’s prices, but I can’t find a way of choosing between them.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head owns shares in SSE. The Motley Fool UK has recommended Centrica. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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