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SSE - Earnings expectations increased

George Salmon | 31 January 2018 | A A A
SSE - Earnings expectations increased

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SSE plc Ord 50p

Sell: 1,765.50 | Buy: 1,767.00 | Change -10.00 (-0.56%)
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SSE's third quarter trading update confirms earnings per share are set to come in around 116-120p. While lower than last year, this is slightly above prior market consensus. The group also intends to continue with the policy of paying dividend increase that at least keeps pace with RPI inflation this year..

The shares rose 1.7% on the news.

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Our View

In November SSE announced its intention to demerge its UK retail business, which will join forces with npower to create a new company. With the dominance of the big 6 attracting negative headlines in recent years, this might seem a surprising move, but scratch the surface and the rationale for the deal becomes apparent.

Customer numbers have been falling in the Retail business, while political pressure on energy providers has been growing from MPs in both the blue and red corners. Standard variable tariffs have incurred particular wrath, and SSE has the highest percentage of customers on SVTs of any of the big players.

Should the deal go ahead, the combined SSE and npower group would have around 12.7m customers. That would give it increased scale and a sharper retail focus. Significant cost synergies should be available too. For the Retail business then, we feel the deal makes sense.

The question is, where does that leave what's being left behind?

On the positive side, what's left of SSE will have a higher percentage of profits from regulated activities. For a business that wants to churn out a reliable dividend, that's no bad thing. However, despite an impressive 25 year record of dividend increases, free cash flow has seldom covered the dividend in recent years.

While the regulated parts of the business should generate stable revenues, they also require significant investment. By comparison, splitting off the Retail business will remove a valuable source of cash. Clearly, in the long-term, the group needs to generate enough cash to maintain and upgrade its assets and still have enough left over for shareholders.

We'll also be keen to find out exactly what the balance sheet looks like post-split. At a minimum, SSE will need to ensure it retains its solid credit rating, while we'd hope the group can unload a good chunk of its debts onto the newly formed retail businesses. A lower level of leverage would mean the group has a bit more headroom, and interest costs would be more manageable.

For now, the shares offer a prospective yield of 7.3%.

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Third Quarter trading details

Within the Wholesale division, electricity output across coal, gas, hydro and wind assets rose from 18TWh to 25TWh, driven by a 25% increase in the output of renewable energy as a result of wetter and windier weather. Hydrocarbon production fell, with lower gas and liquids volumes.

Retail customer accounts have fallen by 400,000 over the 12 months, to 7.68m. However, the decline in the third quarter was a more moderate 40,000.

SSE's capital expenditure is still expected to be around £6bn over the four years to March 2020, but this year's is set to come in at £1.6bn, £100m lower than anticipated. Year-to-date spending totals £1.1bn and includes; £355m in the Wholesale division in on- and offshore wind, £558m in Networks on Electricity Distribution and Transmission, and £140m in Retail on the roll-out of smart meters.

Alistair Phillips-Davies, Chief Executive of SSE, said "The energy sector continues to present a number of complex challenges to manage but, throughout this financial year, we have kept our focus on delivering the best possible service for our Networks and Retail customers and on delivering our programme of investment in the energy infrastructure on which all customers depend. All of this represents an encouraging year so far for SSE."

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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.

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.


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