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SSE - profits fall as expected

George Salmon | 14 November 2018 | A A A
SSE - profits fall as expected

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SSE's half year results are well behind what had been hoped for earlier in the year, but marginally ahead of rebased expectations set out in its last trading statement.

The shares moved slightly her on the news.

The interim dividend has been increased 3.2% to 29.3p per share. SSE still expects to adhere to its five-year dividend plan, which means targeting paying 97.5p in total this year.

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Our view

Scotland can be relied on for lots of good things. For SSE these include plenty of wind and rain. That should mean the weather-related headwinds in the first half prove short-term in nature. But with investment spending stretching well into the billions and debts stacking up, we can't help but think this half's missing profits will be sorely missed.

The shakeup in the Retail business isn't helping either. Customer numbers have been falling and political pressure has been growing from MPs in both the blue and red corners. Standard variable tariffs have incurred particular wrath, and SSE has one of the highest percentage of customers on SVTs of any of the big players.

The group has decided splitting off most of the Retail business, and merging it with npower via a separate listing on the UK market, is the way forward. The plan has been given the thumbs up by SSE shareholders and the CMA.

While a tougher regulatory environment means margins are tightening, the combined SSE and npower group will have increased scale and a sharper retail focus. Significant cost synergies should be available too. All in all, we feel the deal makes sense.

The question is, where does that leave investors?

What remains of SSE will have a higher percentage of profits from regulated activities. For a business that wants to churn out a reliable dividend, that should be no bad thing.

SSE is confident of paying out at least 80% of its pre-split dividend after the demerger. That implies investors will get a prospective yield of over 7% in 2020, plus any income paid by their shares in the new listing.

However, splitting off the Retail business will remove a valuable source of cash flow. This is important as the Networks business, while capable of delivering reliable revenues, requires significant ongoing investment, and is also likely to see allowed margins drop as rules stiffen.

In recent times, SSE hasn't always had enough cash to cover both its outgoings and the dividend. That's seen debts rise. The group won't be able to leverage up its balance sheet forever, so if the dividend is going to be as sustainable as the energy it's producing, SSE will need to deliver improvements.

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Half year trading details

Operating profit, adjusted to exclude the contribution of SSE Energy Services, is down 24.4% to £448m.

That was mostly due to significantly lower profits in the Wholesale division, where profits fell from £160m to just £2.3m as a result of unfavourable weather impacting generation, and the effect of persistently high gas prices on the Energy Portfolio Management business.

The Networks division saw profits rise 6.9% to £380m, with gains in electricity transmission more than offsetting a 5.2% fall in distribution profits, as the group felt the impact of weather-induced fault costs.

The majority of the Retail business has been classed as discontinued pending the tie-up with innogy, and adjusted operating profit across the remaining businesses was £67m, compared to £77m last year.

Investment and capital expenditure on Networks totalled £349m, with £245m on Renewables, which is to be consolidated as a more independently run business. Other expenditures, including on the retail, enterprise and thermal divisions totalled £190m. The group's investments helped regulated asset value rise 7.3% to £8.6bn.

Looking further afield, adjusted operating profit for the Networks businesses is expected to increase by a mid-single digit percentage in the year to 31 March 2019, while losses in Energy Portfolio Management are now expected to be slightly lower than previously forecast, at around £300m. The group hasn't issued firm guidance for the Wholesale division.

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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. 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.