UK utility stocks to buy for the dividend

As other sectors ditch dividends, investors turn to these old favourites for greater income certainty.

With income from UK dividends the weakest since 2010, investors will be looking to safer havens, including Severn Trent (LSE:SVT) and National Grid (LSE:NG.), to make up some of the shortfall.

Ahead of next month's reporting season, experts at Deutsche Bank have analysed what might be on offer from a European utilities sector where an overall 4.8% forward dividend yield should be appealing in the current climate.

The note, published this week, features ‘buy’ recommendations for National Grid, Pennon Group (LSE:PNN), United Utilities (LSE:UU.) and Severn Trent, with SSE (LSE:SSE) the only UK stock to be rated at ‘hold’.

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The focus on investor income in utilities is particularly relevant on the day that the latest UK Dividend Monitor report from Link Group revealed that overall dividend income dropped 49.1% to £18 billion, the lowest figure for the September quarter in a decade.

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Retailers, oil companies and miners were among the culprits for £14.5 billion of lost income, prompting investors to turn to some old favourites for more dividend certainty.

That's not to say the utilities sector is not without its risks, with the Covid-19 pandemic set to increase bad debts and reduce income from industrial and business customers.

The crisis failed to stop Severn Trent from lifting its final dividend in May as part of its stated policy at the time to grow the pay-out by at least 4% above retail price inflation.

Deutsche Bank expects the water company's interim results on 26 November to show a 1% increase in dividend per share to 40.6p. This is based on the start of a new five-year regulatory framework where the company promises a dividend at least in line with CPI inflation.

The pay-out growth comes despite price cuts imposed under the new Ofwat agreement and the impact of Covid-19 meaning the company is likely to post a 24% drop in earnings per share (EPS) to 52p in the six months to the end of September.

A day earlier, United Utilities is expected to give more details on is dividend policy after telling investors in May that it first wanted a clearer picture of the post-Covid-19 economic environment. Its operations are focused on the North West region, where lockdown restrictions have been tightened in major communities including Manchester and Liverpool.

Deutsche forecasts a 12% drop in EPS to 25.6p but thinks that the interim dividend should still grow 1% to 14.4p in line with a policy to target annual rises in line with CPI Inflation through to 2024/25. The note said: “This should, if we are right, be a positive catalyst for the shares.”

At South West Water owner Pennon, the focus of investors in the interim results on 24 November will be on the potential use of proceeds from July's sale of recycling and waste management business Viridor for £4.2 billion.

Pennon said last month that it was reviewing the “most efficient and effective” method of returning value to shareholders, alongside earnings-boosting market opportunities.

Deutsche estimates that the company could return or reinvest £2.6 billion, which is more than half its market valuation. It is braced for the announcement of a new dividend policy and said that a decision to return most of the proceeds from the Viridor deal would be materially positive for the shares.

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National Grid is due to report half-year results on 12 November, when a forecast 10% drop in adjusted EPS to 13.9p is expected to reflect Covid-19 related costs and volume impacts. The dividend per share is set to grow in line with policy by 1.5% to 16.8p, with net debt up to £30 billion from £27.8 billion.

Investors will be looking for further guidance about the pandemic, given that results in June highlighted a £400 million full-year impact split between bad debts, deferred price increases and additional operating costs.

Deutsche expects SSE to report a 37% drop in adjusted EPS to 11.3p, which is in line with the company's guidance for a figure between 10p and 12.5p and an increase in the dividend of 2% to 24.4p a share. SSE has said its five-year dividend plan to 2022/23 will include an 80p plus RPI full-year dividend for 2020/21. 

The company recently set out plans to invest in the green economic recovery, with £7.5 billion of capital expenditure in low-carbon projects, primarily in renewables and electricity networks.