Right now I’m analysing some of the most popular companies in the FTSE 100 to establish if they are attractive long-term buy and forget investments.
Today I’m looking at SSE (LSE: SSE) (NASDAQOTH: SSEZY.US)
What is the sustainable competitive advantage?
SSE supplies electricity and gas to just under 10% of the UK’s population. In addition, the company runs the UK’s fourth largest telecoms network, which makes SSE the country’s broadest based utility company.
However, despite SSE’s size and diversification, the company lacks the ability to be able to set the prices that it charges to customers, as these are tightly controlled by regulators and only allowed to rise by a certain amount every year.
Unfortunately, this lack of pricing power means that SSE has no control over its profit margin and rapidly rising costs are starting to squeeze income. In particular, SSE’s net profit margin stood at 5.3% during 2012, but fell to 1.5% during 2013.
What’s more, it would appear that the company’s peers are not suffering the same margin pressures. Over the same three-year period the net profit margin of peers, National Grid and United Utilities remained relatively constant, averaging 18% and 20% respectively.
Furthermore, SSE’s free cash flow (cash from operating activities – capital spending) only averaged £276 million a year, for the past three years, hardly enough to cover the aggregate dividend payment of £500 million.
Company’s long-term outlook?
The utilities sector is highly defensive so, over the long term, SSE should continue to see a sustained demand for its products and services.
Having said that, the company’s apparent lack of pricing power means that profits are highly erratic and unpredictable, not a good trait in a good buy and forget share.
Nonetheless, SSE is investing heavily in renewable energy projects. Indeed, the company recently sold four wind farms to Greencoat Capital, which has put together a portfolio of wind farms under the company name of Greencoat Wind. SSE owns 16% of the new fund and is contracted to maintain the wind farms.
Lastly, the company continues to be subject to the scrutiny of regulators from time to time and this can have a serious effect on the SSE’s outlook if the firm is found to be using unfair trade practices.
Foolish summary
All in all, as a defensive utility company, SSE has some desirable buy and forget qualities. However, in comparison to its peers the firm’s income is highly erratic and for the last three years, the dividend payout has not been covered by free cash flow.
So overall, I rate SSE as an average share to buy and forget.
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In the meantime, please stay tuned for my next FTSE 100 verdict
> Rupert does not own any share mentioned in this article.
