Why SSE Beats National Grid and Centrica

LONDON -- In my last pick-of-the-sector report, I went for Barclays in the banking sector, and today I'm turning my attention to the utilities providers -- the suppliers of gas, electricity and water.

There are five utilities suppliers listed on the FTSE 100 -- Centrica (CNA +3.07%), National Grid (NG +2.20%), Severn Trent (SVT +1.08%), SSE (SSE +1.94%), and United Utilities Group (UU +1.79%) --  and though there probably isn't much to choose among them, I'm going to put them to the test.

Here's a quick comparison:

Share price growth is over the past 12 months, historic figures are for the last reported full year, forward figures are for the next forecasts.

One immediate difference is the higher P/E valuations of the two water companies, but that's not really surprising as they do have bigger moats around them -- it's a lot easier to plug a generator into the grid than to build a new reservoir. Other than that, we see pretty similar valuations across the board.

Are they cheap?
If the sector is undervalued, then what might a more reasonable longer-term valuation look like? I think we can get a feel from that from the recently aborted takeover attempt of Severn Trent. In its third and final failed try, LongRiver Partners made a bid of £22 per share, which was worth £21.54 once the already-declared final dividend of 45.51 pence per share was taken into account.

That's a premium of 21% over the current share price, and was almost contemptuously rejected by the Severn Trent board. Whether that was a fair valuation is hard to say, but it does tell us the price levels that people are haggling over.

Regulation
Moving in to the gas and electricity suppliers, one looming risk comes from Ofgem's plans to further open up the energy market by forcing firms to post advance prices and make it easier for smaller operators to buy and sell power. But whether that will make a significant difference to the profitability of the companies we're looking at here is not at all certain.

So which is best?
If I had plans to buy just one of these five, I think I'd rule out the two water companies -- their valuations look just a little too rich, and I feel that the stronger future demand is going to be for energy. And even with possibly new regulatory and competition threats, the valuations and dividends across the sector still look attractive.

But which is it to be? Well, I don't put too much store on year-by-year earnings growth figures, because they are erratic, and as there is no differentiation in the products, I'd expect long-term profitability to not vary very much across the industry.

It's essentially all about dividends for me, and the higher dividend from National Grid and SSE needs to be contrasted with Centrica's better cover -- though higher P/E.

My final pick goes to SSE, which I have actually just added to the Beginners' Portfolio watchlist. A forecast dividend yield of 5.8% from shares on a P/E of just under 13 looks desirable to me, and I see no reason why the annual payout can't be sustained at those levels.

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