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SSE - Expecting short-term headwinds in half year results

George Salmon | 27 September 2017 | A A A
SSE - Expecting short-term headwinds in half year results

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In a brief trading update prior to half year results due on 8 November 2017, SSE reiterated previous guidance, and left the dividend policy unchanged. The shares were little moved 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 6.7% 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 was something of a rarity. Over the last three years, total dividends have exceeded free cash flow by more than £400m. 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 around £10bn on capital expenditure, net cash generated from operations hasn't moved a great deal in the last 7 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.

Trading update:

In line with previous guidance, the group expects a reduction in Networks' half year adjusted operating profit, which will be impacted by a temporary decline in Electricity Transmission base revenue and the SGN sale.

This means that, despite profits set to rise in Wholesale and Retail, SSE anticipates reporting adjusted earnings per share for the six months to 30 September 2017 of between 30p and 32p, compared with 34.2p in the same period in 2016.

Longer term guidance remains unchanged. The group will continue to target paying dividend increases of at least the rate of RPI inflation, with the payout between 1.2 and 1.4 times covered by earnings. As previously disclosed, coverage is set to be on the low side this year.

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.

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