Tempted by the SSE share price? Here’s what you need to know

Shares in SSE plc (LON: SSE) have a prospective dividend yield of nearly 9%, but such yields don’t come without their downsides.

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‘Big six’ energy supplier SSE (LSE: SSE) this week warned that its profit for the first six months of the year would fall to around half that of a year earlier. The profit warning surprised investors and shares in the dividend staple fell 8% on the day.

Why?

SSE blamed the slide in profits mainly on short-term factors, including the rise in wholesale gas prices. The weather, which was unusually dry, still and warm, not only reduced household use of gas and electricity but also lowered the amount of electricity generated by renewables. Meanwhile, the company only raised prices once this year, unlike many of its competitors.

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The issues in the first half of the year seem to be only short-term in nature, but this week’s profit warning shows that volatility in the overall performance of the wholesale businesses may be here to stay. What’s more, some headwinds aren’t going to ease any time soon, with Ofgem’s proposed price cap set to add to retail pricing pressures and significantly lower adjusted operating profit for the retail business in the full year.

Dividends untouched

That said, the company remains committed to the dividend policy set out earlier this year, which underscores management’s confidence in the underlying performance of SSE’s businesses. The company expects to raise this year’s dividend by 3% to 97.5p, representing dividend growth which is broadly in line with expectations for RPI inflation. At its current share price, this would give its shares a prospective yield of nearly 9%.

And following the planned spin-off of its retail supply business to shareholders (and merger with Innogy’s Npower), SSE plans to re-base its dividend payout to 80p per share in 2019/20, before returning to dividend growth which will keep pace with RPI inflation in the three following years to March 2023.

Water companies

It’s not just the shares of energy suppliers that have been hit by pricing pressures. Water companies, such as United Utilities (LSE: UU), are set to face a tougher regulatory regime, with the regulator Ofwat signalling a much stricter price control regime for the upcoming regulatory review.

In its submission to the regulator, United Utilities has pledged to cut average bills by 10.5% in real terms between 2020 and 2025 — a reduction of roughly £45 per customer. It’s a significantly bigger cut to average bills than five years ago, and has sparked concerns about the safety of its dividends beyond 2020.

5.6% yield

The company, which has forecast dividend cover of around 80% next year, will likely find it difficult to afford its current progressive dividend policy, especially given its high debt pile. Net debt (including derivatives) was £6.87bn as at 31 March 2018, up from £6.58bn last year.

Shares in United Utilities have dipped by more than 20% over the past year, which has helped push up its dividend yield to 5.6%. This is significantly higher than its five-year average dividend yield of 4.2%, and could trend even higher with RPI-linked dividend growth already pledged for the next two years.

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Jack Tang has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

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