It’s been a long time coming, but I’m starting to feel that there’s a clear route forward for utility group SSE (LSE: SSE).
In this piece I want to explain what’s changed and why I think the shares might be worth buying. I’ll also take a look at an alternative income stock that’s focused 100% on wind power.
This week’s half-year results brought news that SSE plans to create a new business, SSE Renewables. This company will be responsible for all of the group’s renewable energy activities, which include 4GW of wind, hydroelectricity and pumped storage assets.
This new business plans to expand outside the UK and become a leading player in the financing and development of new renewable projects. I suspect this could be the start of a plan to reduce the company’s dependence on the regulated UK utility market.
Putting up a hedge
SSE’s coal, oil and gas-fired power stations account for a further roughly 4GW of generating capacity. Profits from these fossil fuel burners are heavily dependent on commodity prices.
Price movements have caused problems for the firm this year. Wholesale profits fell by 98% to just £2.3m during the six months to 30 September. A repeat of these events could put the dividend at risk.
To prevent this, the group is planning a new approach to commodity trading that will use derivative contracts to lock in power prices for the 12 months ahead.
What could go wrong?
SSE’s plans to merge its retail business with that of npower to form a new company have run into problems. The government’s planned energy price cap has hit profit forecasts. In turn, this is affecting the new company’s ability to borrow money.
I suspect a solution will be found, but this could come at a cost to SSE. The other changes I’ve explained above will also take some time to deliver results.
My view is that the next year could be a bit messy for SSE. But beyond that, I think the outlook is much improved, with a clear strategy and a more affordable dividend.
City analysts appear to agree. They expect adjusted earnings to rise by 23% in 2019/20. This puts the stock on a forecast P/E of 10.5 with a dividend yield of 7.2%. In my view, today’s share price could be a good entry point for a long-term income buy.
If you like the idea of investing in renewable energy but don’t want to invest in a utility stock, one company I’d consider is FTSE 250 firm Greencoat UK Wind (LSE: UKW).
This infrastructure fund invests in a mix of onshore and offshore wind projects. Since its flotation in 2013, it’s provided a dividend that’s kept pace with inflation. The shares currently offer a forecast yield of 5.4% for 2018.
My impression is that the group is well run and offers a sustainable dividend. I only have two real concerns. The first is that future governments could unexpectedly alter the subsidies available to wind power generators, affecting profits.
The second risk is that investor demand for reliable income investments has pushed the share price up to 127p, 11% above the fund’s net asset value of 114p per share. If interest rates rise significantly, I could see the stock falling by 10% or more.
Despite these concerns, this is a stock I’d be happy to pick for a buy-and-forget dividend portfolio.
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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.