When I think of electricity and gas utility company SSE (LSE: SSE) (NASDAQOTH:SSEZY.US), two factors jump out at me as the firm’s greatest strengths and top the list of what makes the company attractive as an investment proposition.
1) Diversified operations
SSE has electricity distribution operations in the North of Scotland and Southern England; electricity and gas supply contracts; gas production, distribution and storage businesses; and interests in electricity generating assets. That’s a good mix of operations from which the company earns around 97% of revenue in the UK and 3% in Ireland. With such a well-diversified utility business, good financial performance in any one business area could offset poorer performance in another.
To illustrate the point, SSE delivered a 17.4% decline in adjusted earnings per share with its most recent half-time report and that performance was due to a mixed operating performance. The energy distribution and transmission operation saved the day by producing 74% of operating profit with the remaining 26% coming mostly from electricity generation. Those figures carried the firm’s retail energy supply division, which delivered an operating loss over the period. In future periods, the various operations of the company could perform differently but the overall trading result seems set to benefit from the firm’s diversity, which helps mitigate trading risk.
2) Steady cash flow
Gas and electricity customers have some choice but the reality is that it’s hard to change suppliers, and impossible to do so frequently, without incurring charges thanks to contract lock-in clauses. That adds up to utility customers being relatively ‘sticky’ and, of course, the product has great repeat-purchase credentials. All of which generates the great attraction for utility investors: steady cash flow:
| Year to March | 2009 | 2010 | 2011 | 2012 | 2013 |
|---|---|---|---|---|---|
| Net cash from operations (£m) | (46) | 1,689 | 2,050 | 1,708 | 1,977 |
SSE seems determined to remunerate investors with annual above-inflation increases in the dividend and that is one thing that depends on good cash flow. The firm reckons it has an unbroken record of better-than-inflation dividend-raising stretching back to 1999, which is impressive, and one reason why dividend-hunting investors flock to the shares. Such a well-engrained tradition is hard for any top executive to break, so it’s on that understanding that we entrust our capital with the firm.
However, despite the advantages outlined here, the trading environment isn’t easy for the utilities, so I’m looking forward to seeing how the company is coping when it updates the market with its full-year results due around 21 May.
What now?
SSE’s forward dividend yield is running at an attractive 6.6% for 2016.
