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This overlooked FTSE 100 5% yielder could be a retirement buy

Water regulator Ofwat has just published its review of the supply disruptions seen during the “beast from the east” earlier this year. FTSE 100 firm United Utilities Group (LSE: UU) came out well ahead of its geographic neighbour Severn Trent, which was one of four firms singled out for criticism.

All else being equal, I prefer to invest in companies that treat their customers well. I reckon there’s less risk of nasty surprises or future mishaps. And I think there’s a good chance operational excellence will also be reflected in a company’s financial management.

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Water utilities are starting to feel political heat about the way they manage their finances. A particular concern is the level of dividend payouts, relative to profits.

United isn’t the worst offender here, but last year’s dividend payout of £270m still accounted for 76% of the group’s reported profits of £354m. In contrast, the group only spent £149.5m on infrastructure renewal last year.

Is this a problem? If the profit margins allowed by the regulator are cut, then the group’s dividend could become hard to afford. But even allowing for this risk, I suspect United will remain a solid investment for income-only investors.

The firm’s shares have fallen by nearly 20% over the last year, lifting the forecast dividend yield to 5.3%. At this level I believe the shares could be worth buying for a long-term income.

A better choice for dividend growth?

Traditional utilities are feeling some political heat at the moment. If you’re unsure about investing directly but would still like some exposure to this income sector of the market, one alternative is FTSE 250 firm Telecoms Plus (LSE: TEP).

This business trades as Utility Warehouse and uses its bulk-buying power to sell bundled utilities to customers. The company expects to benefit from the energy price cap planned by regulator Ofgem later this year, as it will be able to pass on lower costs to its customers. This will make it easier for the firm to compete against smaller energy suppliers who are winning market share by offering cheap introductory deals.

A good set of figures

Today’s results suggest the business is still growing, even without this potential tailwind. Revenue rose by 7.1% to £792.9m during the year to 31 March, while adjusted pre-tax profit climbed 1.8% to £54.3m. The dividend will rise by 4.2% to 50p per share, giving a yield of about 4.7%.

Customer numbers rose by 0.5% to 610,739, but the number of services sold rose by 2.2% to 2.3m. Almost 20% of customers now take all five of the group’s services (landline, broadband, mobile, electricity and gas).

Is the dividend sustainable?

The firm’s balance sheet looks healthy enough. Year-end net debt of £11.2m isn’t significant given the group’s profits.

Like United Utilities, Telecoms Plus pays out very generous dividends. Last year’s dividend of 50p per share accounted for 90% of adjusted earnings of 55p per share. And my calculations suggest that this payout won’t quite be covered by free cash flow.

The big difference here is that Telecom Plus’s business doesn’t require much working capital or investment. If earnings remain stable, I’d expect the dividend to be sustainable.

Broker forecasts for 2018/19 put the stock on a P/E of 17 with a prospective yield of 5%. At this level, I think the shares are worth considering as an alternative to traditional utility stocks.

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Roland Head has no position in any of the 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.