Utility stocks are supposed to be solid, income-producing safe havens, but it doesn’t always play out that way.
Tough times
British Gas owner Centrica, for example, has had a torrid time, turning £1,000 into £322 in a decade, while the sector as a whole has faced down an existential threat, with the prospect of wholesale nationalisation from Jeremy Corbyn’s Labour Party.
That risk has now lifted, and sentiment towards the energy sector is reviving. Centrica is up almost 9% in the last month, while FTSE 100 power giant SSE (LSE: SSE) has climbed almost 7%.
This has been a terrific income stock, but its share price has languished for years. That is now changing, with the SSE share price up 30% in the last 12 months, giving investors growth on top of the group’s juicy yield.
Fund manager Carl Stick, who has managed the Rathbone Income Fund since January 2000, is a long-standing fan. SSE is the only stock to sit in his fund for the entire 20 years of his tenure, as he recently wrote in Investment Week.
His friend electric
It served him well in the noughties, with a total return of 273% versus just 19% for the FTSE All-Share, but the past decade has been more pedestrian. Stick stood by SSE, and reckons the tide is now turning in its favour, as it aims to sell off its retail business this year (subject to approval from competition authorities), switches off its coal-fired power stations in March, and pursues plans to become a leader in renewable energy, with the aim trebling renewable electricity output by 2030.
I incidentally hold Rathbone Income in my portfolio of funds, so I’m glad to see him make positive stock picks like this one, although I have been more sceptical about SSE myself. Last August, I noted that it was on the back foot, with earnings per share falling in three out of five years, net debt of £9.5bn and climbing, two ratings agency downgrades and a 38% slump in pre-tax profits to £725.7m.
I still came out in favour due to its low valuation and 7.1% yield, and have been pleased by its recent recovery.
Not as cheap as it was
Today, its market cap stands at £14.58bn, up from £11.85bn in August, although it now trades closer to fair value, at 14.3 times forward earnings, against 12.5 back then. The opportunity to buy it at a bargain price has slipped away, sadly.
The yield is less dramatic too, at 5.7%, with cover of 1.2. However, what you do get now is a greater degree of confidence in the company’s prospects. Earnings are forecast to grow 31% in the year to 31 March 2020, then 15% the year after (although analysts expect a slight dip after that).
So in the short run, the SSE share price may idle. However, management has shown itself forward looking, by positioning itself for the renewables explosion, which has also removed an area of regulatory uncertainty. SSE now looks nicely set and I would certainly include it in my portfolio, with the aim of buying and holding for the next 20 years.
