Why I’m still avoiding FTSE 100 energy giant SSE and its 8%+ dividend yield

With its eye-popping dividend yield, it’s only natural that energy supplier SSE (LON: SSE) should attract the attention of those looking to generate income from their investments, particularly as savings rates continue to be so derisory. For me, however, the stock is very much one to avoid.

Merger in doubt

Today’s interim results covering the six months to the end of September, while actually ahead of expectations made by the company only a couple of months ago (explaining why the shares are higher this morning), were hardly worth shouting about.

Excluding its Energy Services business, adjusted pre-tax profit fell a little below 41% to £246.4m over the period. On a reported basis, the company posted a pre-tax loss of £265.3m (compared to a profit of £409m a year earlier) and loss per share of 22.6p.

On a slightly more positive note, the £12bn cap stated that the outlook for its Networks and Wholesale businesses for the whole year was in line with that revealed in its last update on trading, with adjusted operating profit for the former set to increase by “a mid-single digit percentage“. The consolidation of all of its UK and Irish renewable energy assets under the umbrella of SSE Renewables was also announced.

Nevertheless, the company has clearly not performed for its owners. With SSE conceding that there was now “some uncertainty” surrounding the proposed merger between its Energy Services and npower as a result of the cap on default tariffs being implemented at the start of 2019, I think the next six months could be just as tough. When it’s considered that the former now expects adjusted operating profit margin at this part of its business to be between 2% and 3% for the current year, down from 6.8% in 2017/18 (and for this to be “lower still” in 2019/20), it’s not altogether surprising that the deal is on shaky ground.

Dividend at risk?

Even after taking into account this morning’s positive reaction, SSE’s share price has dropped by 14% in the last year, leaving its stock trading on 12 times earnings and offering a massive forecast yield of 8.3%. While such a high payout is usually indicative of an imminent cut, the actions of SSE’s management suggest otherwise.

In spite of today’s woeful numbers, the company saw fit to announce an interim dividend of 29.3p per share, equating to a rise of 3.2% on that awarded in the previous financial year. In addition to this, SSE stuck by its recommendation of a 97.5p per share payout for the full year, in accordance with the five-year plan revealed to the market back in May. Time will tell whether this was a good call or not. Personally, I find the fact that this dividend isn’t likely to be covered by profits sufficiently worrying.

But it’s not just low dividend cover, growing competition and political interference that makes me wary of companies such as SSE. Thanks to their tendency to offer bigger yields than firms in other sectors, utility stocks have been in great demand during this extended period of low interest rates. With rates beginning to rise again, these businesses could suffer more than most as investors move away from bond proxies and into other assets.

If you’re seeking safe and dependable dividends, I think it would be best to look elsewhere.

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Paul Summers 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.