British Gas owner Centrica (LSE: CNA) and electricity and gas supplier SSE (LSE: SSE) are paying storming amounts of income right now, among the highest on the FTSE 100. Which is both exciting, and also cause for concern.
Power plays
Right now, Centrica yields an astonishing 8.38%, the highest on the index. SSE runs it close in third place, yielding 7.56%. By comparison, the average easy access savings account pays just 0.53%, which means you get almost 16 times that income level from these stocks. Naturally, this also comes with greater risk.
The first threat is to your capital. Both stocks have fallen sharply over the past year, with Centrica down 28% and SSE down 13%, against a rise of around 2% on the FTSE 100. Things look even worse measured over five years, with Centrica down 63% and SSE down 19%, while the FTSE 100 is up 17% over the same period.
Frozen out
It has been a tough time for the utility sector generally, amid political threats of price freezes and renationalisation, growing competition and heavy investment programmes, while weak energy prices have squeezed profits from electricity generation. Anybody who still considers this to be a defensive sector should think again.
However, share price weakness could also be a buying opportunity. For example, Centrica currently trades at just over 11 times earnings, which my Foolish colleague Peter Stephens thinks looks ludicrously cheap, especially as it shifts away from riskier oil and gas exploration to the more secure task of supplying domestic energy.
Take cover
The dividend looks stretched with cover of just 1.1 times from earnings. It has been held at 12p per share for the last three years and this should continue this year. Analysts are pencilling in a small cut to 11.4p in 2019 but this is hardly disastrous, as it would still leave the yield at a far-from-negligible 7.8%, with cover of 1.14.
Centrica’s forecast earnings growth looks sluggish, just 2% this year and 1% in 2019, but this marks a big improvement on the previous four years, which were all in the red. I do not anticipate a quick share price turnaround, though. Margins are wafer thin at 4%, although planned cost-cutting could help. It is still worth considering for the warm glow of that bumper income.
Electric avenue
Peter Stephens looked at SSE recently and concluded its income prospects remain resolutely bright, as it pursues plans to merge its retail arm with Npower to create a dominant utility player. SSE is even cheaper than Centrica at 10.35 times earnings which again looks tempting. However, earnings per share of 81.3p and a total dividend per share of 94.7p gives even thinner cover of just 0.85 times earnings.
Management has been part funding the dividend from asset disposals but is still promising progression, which will see the payout climb to 97.5p in full-year 2018/19. It will be re-based at 80p once the Npower takeover has been completed then keep pace with RPI for at least three years after that. Even if the dividend slips from today’s dizzy heights, it should still offer plenty to delight.
