Forget SSE, I’d follow Mark Slater and buy this growth and dividend star

A colourful firework display

I used to think of energy supplier SSE (LSE: SSE) as a dependable old defensive business generating consistent cash flow and paying out regular dividends. But these days, the business is in a state of flux. The gargantuan yield is about to be trimmed down because the firm will soon de-merge its retail energy supply operation to form a new company in combination with NPower’s retail operation. Going forward SSE will operate its network and wholesale businesses.

Capital-intensive operations

Although SSE shareholders will own their own little chunk of the de-merged operations, I still reckon all this change is unsettling, and judging by SSE’s lacklustre share-price chart, the market agrees. However, I’ve been rethinking my opinion about owning shares of companies involved in producing energy altogether. These days, I’m no longer as certain that such businesses are as defensive as I once thought. The sector is characterised by capital-intensive operations, which often leads to high debts and thin dividend cover. On top of that, firms like SSE seem to be vulnerable to weather events and other factors that can make their profits and cash inflows behave more like cyclical companies than defensives.

Just this July, SSE told us that “dry, still and warm” weather has led to lower-than-expected output of electricity from renewable sources, lower volumes of energy being consumed, and a higher cost of electricity and gas. The bottom line is that operating profit in the first quarter of the trading year came in around £80m lower than expected. It seems to me that SSE has a lot of risk in its operations and I think it’s possible to invest better elsewhere.

An energy firm minus the hassle of owning energy assets

Rather than betting on SSE and having your capital tied to the nuts and bolts of producing energy we can instead invest in a firm that skims a profit from energy use without risking capital on producing the stuff. I reckon energy procurement consultant Inspired Energy (LSE: INSE) fits the bill nicely because it acts like an agent connecting suppliers with customers. Well-known fund manager Mark Slater has a chunk of his fund’s capital in the stock, which is encouraging because he has a decent track record in investing.

Today’s half-year results are good. Revenue came in 33% higher than the equivalent period last year, cash from operations shot up 43% and adjusted diluted earnings per share moved 13% higher. The directors pushed up the interim dividend 19%, which I take as a message that they are confident in the outlook. Reading through today’s report, I get the strong impression that the management team is going for growth in a determined way. So far, financial progress has been achieved both organically and via an acquisition strategy and both methods look set to continue.

The current share price around 20.65p leads to a forward price-to-earnings rating for 2019 of just over 12 and the forward dividend yield runs around 3.5%. I think the valuation is undemanding and the stock looks attractive given the firm’s growth potential.

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Kevin Godbold 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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