Why I'd sell this FTSE 100 7% yielder to buy this FTSE 250 4% yielder
For dividend seekers, the utilities sector has traditionally been a happy hunting ground and the likes of SSE (LSE: SSE) remain white-hot investment destinations for those attracted by the pull of gigantic yields and the splendid earnings visibility of their operations.
But the game has very much changed over the past five years as smaller, independent suppliers, helped by increased stress on household budgets, have attracted more and more customers with their aggressive promotion-led sales models.
And the situation is becoming more and more difficult for SSE. Indeed, as I noted last time I covered the power play in March, the exodus of previously-loyal customers is intensifying over at the 'Big Six' electricity and gas suppliers, not subsiding. And as the domestic economy struggles and the switching culture becomes ever-more embedded in the British psyche this trend is only set to continue.
Customers still leaving in their droves
This phenomenon was laid bare in SSE's latest set of trading numbers in May. It noted that 430,000 of its clients upped and left during the 12 months to March 2018, taking the total number to 6.8m. The slippage overshadowed its attempts to claw back revenues by hiking prices across some of its tariffs, and caused adjusted profit before tax to fall 6 % year-on-year to £1.45bn.
These price increases from SSE et al, made in an attempt to offset higher wholesale prices, are actually speeding up the outflow of customers on their books. And the latest hike announced by SSE late last month -- which will see more than 2m homes on its standard variable tariff hit with a 6.7% rise in energy costs from July -- is likely to send even more cash-strapped clients shopping for a new deal.
Meanwhile, the impact of price caps tipped for introduction later this year, as well as the possibility of more draconian measures being introduced by regulator Ofgem at a later date, adds another risk to SSE's profits growth further out.
SSE is looking to revamp its downtrodden retail operations by tying them up with those of nPower, the merger anticipated to complete during the first half of 2019. But the tie-up is by no means a foregone conclusion as the Competition and Markets Authority considers whether it will represent a bum deal for consumers.
Dividends rise... But for how much longer?
SSE is trying to put a brave face on things despite its uncertain revenues outlook and rising capital expenditure bill and last month increased the full-year dividend 3.7% for fiscal 2018 to 94.7p per share. Moreover, it announced plans to raise the reward again to 97.5p next year.
And this plump forecast matches predictions from City analysts, meaning that the FTSE 100 business currently sports a chunky 7.3% dividend yield.
However, I am fearful that this target is in danger of missing the mark. The projected dividend is covered just 1.3 times by predicted earnings, well outside the accepted security terrain of 2 times or above.
At the same time, adjusted net debt and hybrid capital rose to £9.2bn as of March and is expected to eventually hit the £10bn marker over the next couple of years, SSE predicts. This provides little wriggle room for dividends to increase should earnings keep on sliding.
It may be cheap, the firm dealing on a forward P/E ratio of just 10.9 times. But for my money the business still carries far too much risk, and this low valuation still doesn't attract me today.
A better income play?
Indeed, those seeking big yielders on dirt-cheap earnings multiples would be much better off checking out SThree (LSE: STHR), in my opinion.
The recruitment specialist has a long record of earnings growth behind it and, with business activity continuing to boom on foreign shores, I am not expecting this trend to cease any time soon. In fact, I am expecting another bright update later this week to provide the share price with fresh fuel.
Returning to the subject of dividends: City analysts are expecting the payout to remain locked at 14p per share for the 12 months to November 2018. However, this still results in a chunky 4.2% yield.
And with earnings predicted to rise 5% year-on-year the anticipated payout boasts bulky coverage of 1.9 times. The business also carries a forward P/E rating of just 12.3 times.
Right now I would consider SThree to be a much better investment destination than SSE. But the FTSE 250 firm is not the only white-hot income pick out there.
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Royston Wild 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.
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