The utility sector has traditionally been the go-to place for high-yield, low-risk defensive dividend stocks. The following two giants certainly score on the yield front, but they also carry more risk than you might expect.
On the grid
UK and US pipelines and pylons giant National Grid (LSE: NG) currently offers a forecast yield of 5.7%, with cover of 1.2. With the Bank of England holding interest rates at 0.5% yet again this month, that is an electric income. The downside is that share performance has been disappointing with the stock down more than 18% in the last year, and trading just 12% higher than five years ago. Many investors have been spooked by its falling earnings forecasts, which my Foolish colleague Roland Head examines here. Others may see the recent dip as a tempting entry point.
You must beware of potential problems. One concern is that Ofgem will squeeze National Grid inside a tighter regulatory structure. There is also the distant threat of a future Jeremy Corbyn-led Labour government nationalising the company, with compensation uncertain.
National power
The company, which has a market cap of £27.64bn, also shoulders the burden of investing heavily in maintaining and developing its infrastructure. Debts rose £3.7bn to £23bn in the year to 31 March, and this should increase to around £25.5bn next year as it continues to invest in the business.
Operating profit fell 8% to £3.5bn last year, although this was mostly due to adverse timings and major storms in the US. National Grid remains a rock solid business, and management is committed to increasing its full-year dividend by at least RPI inflation. City analysts forecast the dividend will hit 5.9% by 2020 and although earnings per share (EPS) may drop 4% in the year to 31 March 2019, they are expected to rise 7% the year after. Trading at 14.5 times earnings National Grid still looks a dividend powerhouse to me.
High energy
Energy company SSE (LSE: SSE) offers an even more compelling forecast yield of 7.3%, with cover of 1.3. Only FTSE 100 giants Centrica and Vodafone offer more generous income.
SSE has been a top yielder for years, and management has given investors plenty of forward visibility as well. Last year’s 3.7% hike to 94.7p per share will be followed by a further hike 3% to 97.5p in full year 2018/19, but the payout will be re-based at 80p after the Npower takeover has been completed. For the three years after that, it should “at least” keep pace with RPI, and that looks sustainable.
Debt issue
Rewarding loyal investors is SSE’s first objective, although it has a lot of it on its plate, with a full-scale CMA investigation of the Npower merger and the loss of 430,000 customers last year. It must also fund another £6bn of capital and investment expenditure, while net debt is expected to peak at around £10bn, before falling to around £9bn by 2023.
Near-term earnings growth projections look patchy but the stock does trade at a juicy valuation of just 10.9 times earnings, which reflects many of the current uncertainties. The income may slip from today’s giddy heights, but should still sizzle.
