Dividend safety is paramount to many retiring investors and that's why I'm taking a look at dividends from the utilities sector in this article. Utility companies are among the most popular stocks for dividend investors because they tend to have very stable businesses, which enable them to offer higher than average dividend yields.
Energy company SSE has been chosen for its tempting dividend yield of 6% and its well-diversified business model.
Like many of its peers, SSE is somewhat exposed to volatility in wholesale energy prices from its electricity generation and supply businesses. To smooth out volatility, big suppliers such as SSE actively hedge against wholesale energy price changes.
But what makes SSE different is that the company also has a sizeable gas and electricity distributions network. To get a handle on the company, it's best to break down the group's earnings into three distinct operations. The regulated networks business is the biggest contributor to earnings, accounting for 51% of the group's operating profits, followed by the retail supply business (25%), and lastly by its wholesale electricity generation business (24%).
SSE's sizeable regulated networks business means that its earnings are generally more stable than it is for rivals Centrica and Drax, and this should make SSE relatively more attractive from an income investor's perspective. That's because SSE generates steady revenues from the levies and tariffs paid by the utility suppliers who need to use its distribution networks, and these revenues are generally unexposed to volatile commodity prices.
The dividend growth over the last three years of 2% annually isn't very impressive, but that could soon change. As SSE has pledged to grow its dividends by at least RPI inflation annually, the outlook for higher inflation in the UK implies SSE is set to deliver faster dividend growth. Thanks to the fall in the value of sterling since the Brexit vote, the Retail Prices Index (RPI) has already risen to 2.5% in December -- looking forward, city analysts expect RPI inflation to peak above 3% this year.
Pennon Group is a solid choice for safety and yield. The current 33.58p per share payout offers potential investors an above-average yield of 4.2%. Although that's not as high-yielding as SSE, Pennon seems to have a lower risk profile.
As a water company Ofwat, the water regulator, conducts a price review to set out what the company must commit to deliver during the period and the price it may charge customers. This gives them a high degree of predictability over future cash flows, which allows it to plan ahead for up to five years in advance.
But unlike peers such as Severn Trent and United Utilities, Pennon also has a waste business. The company's recent decision to invest another £252m in another energy recovery facility shows that there are good opportunities for Pennon to invest in the waste business. Once this spending splurge pays off, the company could be in a stronger position to return more cash to shareholders.
Jack Tang has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.