The SSE (LSE:SSE) share price has been rallying since August and at around £12.95, the price today is closer to the higher end of its 52-week price range.
Compounding dividend reinvestment
SSE’s trailing price-to-earnings ratio (P/E) of 9 is very attractive, as is its dividend yield of 7.5% and earnings per share are £1.38.
With a £10,000 investment today, if I reinvest the 7.5% dividend each year, then compounding the investment would mean I could more than double my initial investment in 11 years. However, this will only happen if its generous 7.5% dividend doesn’t get cut and the share price doesn’t go down, but these are very big ifs.
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In fact, with a dividend cover ratio of only 1.4, a dividend cut is very possible, particularly as its 67% debt ratio is a big problem for SSE. Although the share price has been volatile since a profit warning a year ago, it’s highly likely to fall again as Brexit sees yet another extension and the stock market remains in limbo.
Regulatory and political pressures are increasing in the traditional energy sector with a heightened focus on reducing our carbon footprint.
By concentrating its efforts on renewables and infrastructure, SSE shows it’s committing to transitioning to low-carbon energy. This was recently further evidenced by the sale of its retail business to rival OVO Energy. The Competition and Markets Authority is now looking into the £500m deal to check if it would significantly lessen competition in the sector. With 500m UK households affected by the merger, it’s important to be sure it will not subject them to an unfair increase in their bills.
Networks and renewables
The divestment of its retail arm leaves SSE with its two core segments of networks and renewables. Its networks division is the one that is key to its dividend payout. It’s part of the national electricity grid in the north of Scotland and has a share in gas distribution businesses. If SSE meets its financial and operational targets, it can earn interest on its regulatory asset value (RAV). RAV growth will bring more money to shareholders. Achieving this is possible, but it is complex and the interest rate is not stable.
SSE is heavily invested in offshore wind farms, particularly around Scotland. This is good from an environmental standpoint, but financially it’s weather-dependent.
All things considered, I think SSE is a good addition to an income portfolio, but doubling my money is not a certainty. In theory, I could double my money with SSE, but I think it would be over a much longer time frame than 11 years. In this ideal scenario, the dividend holds, or ideally, increases and the share price continues to rise. As there are many external factors affecting the company’s share price, along with internal issues such as debt, I’m doubtful that it will rise indefinitely and I think the dividend is at risk. Therefore, I wouldn’t expect to double my money with the SSE share price any time soon.
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Kirsteen 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.