If you’re looking for income, investing in a high-yielding British utility company would normally be a no-brainer, especially when you can barely get 1% or 2% on cash. However, these aren’t normal times, especially in the power sector, where the big players are menaced by the energy cap and renationalisation threats, while battling to retain customers who are increasingly switching to smaller rivals.
Risky dividend?
So where does that leave FTSE 100 power company SSE (LSE: SSE)? This is a major blue-chip with a market cap of £11.85bn, but is on the back foot after shedding more than 500,000 households to rival suppliers in the year to April.
The SSE share price now has a tempting forward yield of 7.1%, even if the payout is only covered 1.1 times by earnings. The big question is whether it can endure, given that it eats up almost all of the group’s earnings. Rupert Hargreaves is sceptical, noting that over the past five years, SSE’s net debt has nearly doubled as it borrows to fund its payout. This year debt is expected to creep up again, from £9.2bn to £9.5bn.
The dividend has actually been trimmed since hitting 97.5p in 2019, and now stands at 80p for 2020. That offers some security, and the payout is forecast to hit 82.24p in 2021, as management pursues its five-year dividend plan to 2023.
Chief executive Alistair Phillips-Davies SSE assured markets last month that its dividends should be sustainable, “based on the quality and nature of its assets and operations, the earnings derived, and the value created from them and the longer-term financial outlook”.
Low growth hopes
We’d better hope so, because in a heavily regulated industry like this one, where profit growth is limited, dividends offer your best chance of reward. The SSE share price is down 10% over the last year, and 26% over five.
Earnings per share have fallen in three out of the last five years, including a hefty 21% drop in 2018, followed by a 31% drop in the year to 31 March 2019. In May, the group reported that annual adjusted pre-tax profits slumped 38% to £725.7m. The group has the added burden of investing in infrastructure, including more than £2bn to transform the electricity grid to receive renewables. Moody’s and Standard & Poor’s both recently downgraded its credit rating.
Bargain valuation
SSE now trades at 12.5 times forecast earnings, well below the average of 17.33 times for the FTSE 100 as a whole. With the index yielding 4.7%, you get a higher income too.
All eyes are now on the planned sale of its energy retail business SSE Energy Services, which has 5.7m household customers, as rival Ovo Group circles. A successful outcome could lift both sentiment and the share price.
Utilities is a tough sector these days. Centrica has fared much worse than SSE, its stock is down 80% in five years. Things may get tougher still as the UK transitions to a low-carbon economy, or at least tries to. SSE faces many challenges but don’t despair, Roland Head says its future might look brighter as profits are set to grow.
