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Forget the SSE share price! I’d buy this 6% yielder instead

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At the time of writing, the SSE (LSE: SSE) share price supports one of the highest dividend yields in the FTSE 100. The yield stands at 7.3% compared to the index’s average of around 4.6%. 

For income seekers, this level looks too good to pass up, but I’m not convinced. In fact, I think SSE’s dividend is living on borrowed time.

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Dividend confirmation

A few weeks ago, in a trading statement ahead of its AGM, the FTSE 100 utility group informed investors that its full-year expectations for growth in 2018 remain unchanged, despite “lower than forecast” renewable energy output. Management also reiterated its intention to deliver a full-year dividend of 80p per share.

But away from the headlines, SSE is struggling. Customers are fleeing, and the company is having to fork out more than £2bn to transform the electricity grid to receive renewables. 

Management seems to believe that a company can continue to pay out almost all of its earnings to investors as dividends while maintaining the current level of investment. But I’m not so sure. Over the past five years, SSE’s net debt has nearly doubled as the firm has had to borrow to fund its payout.

With customer losses putting pressure on the bottom line, I think the company will have to make some tough choices when it comes to the dividend and capital spending during the next few years. A dividend cut is likely in my eyes.

Booming demand

As SSE struggles to retain customers and invest for the future, brickmaker Ibstock (LSE: IBST) seems to be powering ahead. Making concrete and clay bricks is hardly an exciting business, but it is a profitable one. Last year, Ibstock reported an operating profit margin of 25%, compared to SSE’s five-year average of 4%. 

The enterprise is riding high on the UK’s booming homebuilding sector. Over the past five years, as the demand for bricks has surged, the company’s net profit has increased at a compound annual rate of 51%. Earnings per share have jumped from 9.2p in 2014 to 16.4p and analysts are predicting 19.5p per share in 2019. 

This growth has allowed management to increase the company’s dividend by more than 200% since 2015, and I think there’s a good chance this growth will continue.

At current levels, the stock supports a dividend of 6.3%, and the payout is covered 1.4x by earnings per share. With analysts forecasting earnings growth of 17% for 2019 and 8% for 2020, there will be plenty of scope for management to increase the distribution in the years ahead without lowering the dividend cover ratio.

What’s more, the company’s balance sheet is also relatively clean. At the end of its last financial year, net gearing was just 11%, compared to SSE’s net gearing ratio of 152%, this looks very healthy. 

The bottom line 

So overall, if I was looking for a market-beating dividend stock to add to my portfolio, I’d sell SSE and buy Ibstock.

The latter’s dividend yield might be lower, but it looks to me to be more secure considering the company’s robust balance sheet and high dividend cover ratio.

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended Ibstock. 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.

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