Shares in utility group SSE (LSE: SSE) plunged at the end of last week after the firm published an unexpected profit warning. According to the company, profits for the first half of the year will now be around 50% lower compared to 2017, thanks to hot, calm weather and gas trading losses.
Many investors haven’t stayed around to find out if trading will improve during the second half. Nearly £18bn worth of shares in SSE changed hands on Thursday when the update was released, and the stock slumped to an eight-year low.
After this decline, shares in SSE support a highly attractive, market-beating dividend yield of 8.3%. However, if you are thinking of buying into the company for its income potential, there are several issues you need to consider first.
For starters, SSE is under attack from all sides. The company can’t control the weather, but this is just one of the headwinds the business is struggling with.
As well as unfavourable weather conditions, SSE is also having to deal with increasing regulatory scrutiny and rising costs. And that’s without considering the impact the introduction of the government’s price cap will have on earnings when it’s introduced in a few months.
Worth the money?
SSE’s uncertain outlook leads me to believe that last week’s profit warning won’t be the last. Analysts have already revised down their earnings expectations for fiscal 2019, from 119p to 97p. But even after this downgrade, the stock is still changing hands for a relatively expensive 11.3 times forward earnings.
To me, this seems expensive for a business with an uncertain outlook.
SSE’s best quality is now the company’s dividend yield which, as noted above, currently stands at 8.3%.
However, I’m not convinced that it will be able to avoid cutting its payout as earnings fall. The current level of distribution is only just covered by earnings — after adjusting for the first-half profit warning. As a result, any further earnings downgrades could threaten the distribution.
Lack of growth
Lastly, even though management has blamed the company’s poor first-half performance on the weather, I’m convinced that SSE’s problems are more structural.
Over the past few years, popular opinion has turned against large utility providers, and a wave of new firms have emerged with the goal of disrupting the market and grabbing unsatisfied customers from large incumbents.
To try and meet this threat, SSE is merging its retail power unit with Innogy’s Npower. But I think this is just a sticking plaster. The UK’s whole utility industry is suffering from disruption, and this will likely mean lower profits going forward.
Considering all of the above, I’m somewhat negative on the outlook for SSE. Even though the company’s dividend yield might look attractive today, it could only be a matter of time before the distribution is slashed as growth stagnates.
I reckon it’s best to avoid the business as there are plenty of other dividend stocks on the market with more sustainable distributions.
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Rupert Hargreaves owns no share 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.