Today I’m looking at two unloved dividend stocks with forecast yields of at least 6%. Although contrarian picks like this aren’t without risk, I believe they give us a good opportunity to lock in attractive income streams.
Powering up for change
The share price of FTSE 100 utility group SSE (LSE: SSE) fell last week after it revealed a 6% drop in adjusted pre-tax profit, which dropped to £1,453.2m during the year to 31 March. Although the company’s unbroken record of dividend growth was maintained with a payout of 94.7p per share, management also announced plans for its first ever dividend cut.
The cut to the payout is expected in 2019/20, following the spin-out of the company’s retail division. It plans to merge this business with the retail division of rival Npower, to form a new company. SSE shareholders will receive one share in the new company for each SSE share they own.
The board plans to recommend a dividend of 97.5p for the 2018/19 financial year, followed by a payout of 80p per share in 2019/20. This will reflect the loss of profits from retail customers and the smaller size of the business.
Why I’d buy
One problem for utilities is that the government has insisted on collecting the costs of its renewable energy policies through domestic fuel bills, rather than funding them through tax. So utility bills are higher than they would be if we were only paying for the fuel we use.
By exiting the retail business and focusing on selling its electricity and gas into the wholesale market, SSE should be able to reduce its exposure to regulatory price caps and political risk. My hope is that this will make the stock more attractive to investors, in the way that National Grid already is.
Analysts’ forecasts currently price the stock on about 11 times 2018/19 earnings, with a prospective yield of 7.1%. If the dividend is cut as expected in 2019/20, then this yield will fall to 5.8% — but shareholders will also receive shares in the new business, which I’d expect to pay dividends.
Political risks are crushing utility groups’ share prices at the moment, but I rate SSE as a long-term income buy.
This is starting to look cheap
Pet superstore chain Pets at Home Group (LSE: PETS) has been a poor investment since its flotation in 2014. The group’s shares are currently trading at a post-IPO low of about 125p. Investors are worried about low growth rates, with earnings per share expected to be flat this year and to rise by just 3% next year.
However, I think this cautious view overlooks the value offered by the group’s strong cash generation. Pets generated free cash flow of £55.8m last year, compared to an after-tax profit of £62.8m. This means the dividend was covered 1.5 times by free cash flow, which is a far better level of cover than many large companies achieve.
Cheap enough to buy
The pet superstore’s shares now trade on a 2018/19 forecast P/E of 9.4, with a forward yield of about 6%.
In my view this could be a profitable entry point. Debt is fairly low and the dividend looks quite safe to me. If Pets at Home can return to growth, these shares could easily be worth a lot more.