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SSE - Facing 'complex challenges' but dividend targets maintained

George Salmon | 20 July 2017 | A A A
SSE - Facing 'complex challenges' but dividend targets maintained

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SSE plc Ord 50p

Sell: 1,644.50 | Buy: 1,645.50 | Change -7.00 (-0.42%)
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SSE's first quarter trading statement confirms the group is maintaining its target of increasing the full-year dividend by at least RPI inflation. The shares were broadly flat on the news.

Our View

SSE's dividend has grown every year since 1992, at a compound annual rate of almost 10% per annum. Against that background the prospective yield of 6.4% is an undeniable attraction. However, in order to sustain dividend growth in the long run, we feel the group's profits and cash flows must improve.

Target dividend coverage has dropped from 1.5x to 1.2-1.4x, and while SSE's free cash flow (cash available after interest costs and capital expenditure, but before disposals) just about covered the dividend this year. That's something of a rarity. Over the last three years, total dividends have exceeded free cash flow by more than £400m. The group has relied on asset disposals, debt, and share issuance to prop up the payout. Clearly this can't go on forever.

SSE has committed to spending in the region of £6bn in the 4 years to March 2020, so cutting back spending in order to free up cash doesn't look likely. Despite spending well over £10bn on capital expenditure, net cash generated from operations hasn't moved a great deal in the last seven years. In order to improve things then, SSE will need to generate a better return from its investments.

Around half of its expenditure will be directed to the Wholesale and Retail operations, where the outlook has been clouded by falling retail customer numbers and Theresa May's plans to cap energy prices. Current projects include seven onshore windfarms, with a capacity of 761MW.

The other half is going into the heavily-regulated Networks division. This division comprises SSE's electricity and gas distribution businesses and makes up around half of group profit. Historically, its steady cash flows have helped support the dividend, but the regulator has told SSE to expect lower returns from 2021, as tougher pricing restrictions come in.

The big question is therefore whether the long term investments SSE is making will lead to significantly higher cash flows in the future. If they do, then everybody's happy. If not, its generous dividend policy might need to be revisited.

First Quarter trading

Wholesale electricity output was 6,963 GWh, up 18% on last year, primarily driven by a 22% increase in gas and oil-fired generation which contributes around three quarters of the total. In renewables, slightly higher wind speeds contributed to a 22% increase from the group's wind turbines, to 1,108 GWh. Hydro output fell 16% to 488GWh as a result of entering the period with below average storage levels. Gas production was also lower.

Retail electricity energy usage was down 3.4%, with gas down 15.4%, as average temperatures were almost 1?C warmer than the prior year. The Networks division saw fewer interruptions and minutes lost.

The group has completed around two thirds of its £500m share buyback programme, which follows the sale of a 16.7% stake in Scotia Gas Networks. The buyback is expected to be concluded by 31 December 2017.

SSE anticipates the dividend to be covered around 1.2-1.4 times earnings this year. However, as previously indicated, coverage is likely to be towards the lower end of this expected range.

Alistair Phillips-Davies, Chief Executive of SSE, said: "There continues to be significant change across the energy sector, but also opportunities for responsibly-minded businesses to contribute positively to its direction in the interests of customers and investors alike."

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.