Not so long ago, many investors said utility stocks such as SSE (LSE: SSE) were too boring to be good investments.
The story now is that they’re too scary, given the twin risks of Labour renationalisation and the spread of solar panels and wind turbines across the UK.
Renationalisation and renewables are both real risks. But history suggests that many such risks turn out to have been exaggerated. Even if the problems are real, good businesses often find solutions that enable them to evolve and profit from the new reality.
Time to buy?
I think we could be approaching a situation like this with the big energy utilities, such as SSE.
For many obvious reasons, I can’t rule out political risk. But I am pretty confident that as the UK’s largest renewable generator, SSE’s portfolio of power assets is likely to remain useful and profitable over the coming years.
The group failed to merge its retail business with that of Npower, but it remains a sizeable operation that generated an operating profit of £122m last year. Efforts are continuing to “secure the best future for the business outside SSE”. I believe an opportunity will be found, perhaps in combination with a smaller energy retailer with a sharper focus on marketing.
What about the dividend cut?
I think it’s probably fair to say that utility stocks became overvalued a few years ago. The dividend also became unsupportable. Both of these problems have now been corrected, in my view.
SSE’s share price has fallen by about 30% in three years. This year will see its dividend cut by 18% to 80p per share, but profits are expected to return to growth, improving the safety of the dividend.
The stock is trading on about 12.5 times 2019/20 forecast earnings, with a dividend yield of 6.9%. I think this could be a smart time for income investors to buy.
I shouldn’t have sold
I’ll start with a confession. I bought shares in FTSE 100 warehouse property REIT Segro (LSE: SGRO) in early 2013, at less than 250p. Today they’re trading at about 770p, with a dividend that’s 50% higher than when I bought.
Unfortunately, I don’t own these shares anymore. I sold them in a mistaken bout of portfolio restructuring back in 2017.
However, even though I really like the long-term investment story around logistics property, I’m not tempted to buy back my Segro shares today.
At the current price, the stock trades at a 14% premium to its net asset value of 673p and offers a forecast dividend yield of just 2.6%. In my view, these aren’t attractive numbers.
Although I recognise that there’s strong demand for well-located warehouses, trees don’t grow to the sky. At some point I’m confident that this cyclical market will slow.
Buying shares in a property company at a premium to their net asset value doesn’t make sense to me. It means that when the market cools, your downside risk is much greater.
I’m not tempted by the yield, either. The FTSE 100 offers a dividend of about 4.3% at the moment. So if I just wanted a simple low-risk income, I’d invest in an index tracker instead.
In short, I like Segro’s business but not its valuation. I plan to wait for a cheaper opportunity to buy. For now, I’d rate SGRO as a hold.
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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.