Is This The King Of Dividend Shares?

Published in Investing on 16 May 2012

A 6% yield and a 13-year record of inflation-beating dividend increases.

Last week, my fellow Fool writer Malcolm Wheatley took a look at the latest bonds issued by Tesco (LSE: TSCO), which offer a 5% income. His conclusion was that while there was nothing wrong with the bonds, Tesco's shares offered investors a much better deal, with a near-5% yield and the likelihood of capital gains to match inflation.

The company I'm going to look at today offers an even stronger case for choosing shares over bonds. SSE (LSE: SSE) is the UK's largest generator of renewable energy, and its second-largest electricity generation business overall.

As a FTSE 100 utility, it offers remarkable stability and is virtually recession-proof. SSE's current yield is about 6% and it has one of the most attractive dividend records in the UK; 13 years of successive above-inflation dividend increases.

Anyone who was lucky enough to buy SSE shares in 1999, when the company paid its first full-year dividend, will now be enjoying an annual dividend more than three times greater than in 1999. Since then, the shares have also risen in value by 130%, providing a fantastic example of the earning power created by buying and holding reliable dividend paying shares.

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Utility or income fund?

Although SSE is in the utility business, it regards the objective of "sustained real dividend growth" as its "first financial responsibility to shareholders" and as "the long-term financial context for its operational and investment decisions".

In other words, this is a company that is absolutely focused on generating a reliable income for shareholders.

Renewable boost

SSE published its full-year results today, revealing a 6.8% dividend increase, taking the total payout to 80p per share. Post-tax profits rose by 7.7% to £1.1bn while investment and capex -- important for a utility -- rose by 18.2%, to £1.7bn.

The business is divided into three main divisions, wholesale (generation), networks and retail, each of which generates a substantial share of the profits:

 Operating profit% Change
Wholesale£607.9m6.4%
Networks£737.1m6.7%
Retail£321.6m-19.7%

A 20% fall in profits at SSE's retail division was caused by three factors: a 19.9% fall in average gas consumption, a 6.9% fall in electricity consumption and the loss of 100,000 customers.

Rising gas prices also hurt SSE in the last year, driving a reduction in 'spark spreads' -- the difference between the cost of gas and the sale value of the electricity it is used to produce. Conversely, SSE's growing gas production unit -- it has interests in North Sea gas -- grew profits strongly.

End-to-end appeal

I wrote recently about BG Group's (LSE: BG) ability to profit from the whole of the gas production and sale cycle, thanks to its end-to-end involvement in the gas industry. SSE's diversity gives it a similar strength, in my opinion.

Its retail and networks businesses enable it to guarantee a large, stable market for its energy, while its electricity generating capacity is split nearly equally between gas/oil, coal and renewable capacity. This allows SSE to rebalance its electricity generation to maximise profitability when fuel prices, carbon costs or weather conditions vary. An added attraction is that SSE was the first company to commit to selling all of its electricity on the open market earlier this year, boosting price transparency in the energy industry.

The final attraction is that SSE's stable, regulated business provides an implicit link between its share price and inflation. Combine this with a 6% yield that has an unbroken record of beating inflation, and you have a very attractive long-term share.

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> Roland does not own any of the shares mentioned in this article. The Motley Fool owns shares in Tesco.

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Comments

The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

mcecaro 16 May 2012 , 4:06pm

how about leverage?

sopavest 16 May 2012 , 4:25pm

@mcecaro

It's true that utilities do tend to be more highly leveraged than average, partly due to their substantial capex requirements.

But they are also a very secure and stable business with reliable access to credit markets and reliable cashflow, making the debt lower risk - in my opinion - than with most other types of company.

Cheers, Roland (article author)

QuantumDealer 16 May 2012 , 8:36pm

So, SSE are...

1. Losing a barrel full of retail customers (>100,000),
2. seeing their margins being squeezed by rising costs (a tighter 'spark spread'), and
3. investing more in CapEx than they make in profits for the full-year by £600m.

Not sure it is as good a buy as you seem to make out.

And the author's comment above of "...making the debt lower risk..." just takes the biscuit. Author, were you once employed by Goldman Sachs?!

duffmanchon 16 May 2012 , 9:10pm

As sure as the sun shines SSE will pay increasing dividends. If I had to pick one share to hold indefinately it would be them.

sopavest 17 May 2012 , 10:10am

@QuantumDealer

Thanks for your coment. In reply to your points:

1. 100,000 is only 1% of their customers and they have recently acquired another 130,000 in Northern Ireland, thanks to a small acquisition. I agree that they seem to have plateaued a little in terms of expansion, however.

2. If higher gas prices persist, consumers will end up footing the bill through higher electricity prices - since SSE generates electricity and sells it to retail consumers, price pressures should balance out over time.

3. I don't think the Capex is that big a problem - National Grid did exactly the same last year (results out today), spending £3.4bn on capex with profits before tax of £2.6bn.

Sometimes it's necessary - utilities' capex projects tend to be huge in scale, so spending is uneven and sometimes disproportionate to earnings.

I can confirm I've never worked for Goldman, but I would be happy to hold utility bonds as I don't think they'd ever be likely to default!

Cheers,

Roland (article author)

westwinds3 18 May 2012 , 7:39am

I'm thinking Hyman Minsky - his financial instability hypothesis, that not only predicted the crash but explained exactly why it would happen. Because utilities appear to be predictable, they load up debt. When times get worse, high gearing makes it harder for a company to pull through. What happens when interest rates double? Will SSE be allowed to double fuel prices? I may be losing out, but I sleep better holding companies with less gearing.

tigerbart2 19 May 2012 , 6:42pm

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