It's Got the Wind at Its Back

08/31/2010 10:15 am EST


Carla Pasternak

Editor, The Income Investor

UK utility Scottish & Southern offers an attractive and safe yield, writes Carla Pasternak in High-Yield International.

Scottish & Southern (London: SSE, OTC: SSEZY) is one of the UK's top energy firms, providing electricity and gas to 9.35 million customers. The company operates 79,300 miles of power lines and generates power for 5.7 million customers. The utility is also involved in natural gas exploration and storage, telecom, and retail appliance sales.

For fiscal 2010 (ended March 31st), operating profits were mostly generated from power generation (55%) and transmission (37%). The company generates power from oil and natural gas (40%), coal (39%), and renewable energy sources like solar and wind (21%). Scottish & Southern is the UK's largest provider of renewable energy and has the nation's largest wind farm.

The utility typically pays dividends twice per year, a smaller dividend in April, and a larger one in October. The April dividend was 31 cents per ADR, and the October dividend has been declared at approximately (depending on exchange rates) 72 cents.

At today's price, the stock yields around 6%. Dividends are paid in British pounds and converted to dollars for American investors, so there is currency risk. Since Scottish & Southern is a UK company, there is no withholding tax.

Dividends have consistently risen [by] an average of 10.5% annually over the past five years, from 42.5 pence per share in 2005 to 70 pence in fiscal 2010. Dividends have been supported by earnings per share, which have risen 10.3% annually over the same period. In fact, profits and dividends have risen every single year since the company's initial public offering in 1998.

Adjusted profit before tax grew in 2010 by about 3% over 2009 to £1.3 billion, a respectable showing in a recessionary economy. For fiscal 2010, earnings per share covered dividends by 1.6x for a manageable payout ratio of 64%.

To maintain its string of rising profits and dividends, Scottish & Southern has invested heavily in system upgrades and expansion. Capital expenditures were £1.28 billion in 2009 and £1.3 billion in 2010. The lion's share of the investments was in renewable energy.

Recent rate regulatory decisions should enable the company to generate at least 5% [annually] in after- tax real returns between 2010 and 2015.

That said, there are risks. Management did say in the latest interim report that first quarter (April 1st through June 30th) electric consumption fell 2% and gas consumption fell 2.4% as the UK economy slowed amid the European debt crisis. However, European economies have since picked up.

Also, the company has a high debt burden, [with] net debt of £5.3 billion compared with £3.1 billion in shareholder capital. However, before-tax profit of £1.3 billion easily covered interest expenses of £230 million in 2010.

For investors looking for a steady and reliable dividend payer with modest growth potential, Scottish & Southern is an attractive choice.

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