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SSE - on track for the full year

Emilie Stevens, Equity Analyst | 31 January 2020 | A A A
SSE - on track for the full year

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SSE plc Ord 50p

Sell: 1,230.50 | Buy: 1,231.00 | Change 11.50 (0.93%)
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SSE continues to expect underlying earnings per share to be between 83p and 88p for the full year, with a dividend of 80p per share.

The shares were broadly unmoved following the announcement.

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Our view

There's been a change in the wind at SSE. The retail business has been sold to OVO and the Gas Production business is on the block too. Going forwards SSE's focus is regulated electricity transmission and a growing portfolio of renewable energy assets.

At SSE's core is its Networks business, which delivers electricity to homes in Scotland and Southern England and owns high voltage transmission cables in the Scottish Highlands and Islands. This is classic utility territory - with revenues almost guaranteed and profits closely regulated. As a result, the group's been firmly in the income category. And until announcing a dividend cut ahead of the separation of the retail division, the payout had grown for over 25 years.

Regulated profits might be more predictable, but they're unlikely to grow quickly, which makes renewable energy SSE's growth engine. Increasing concern about climate change is ramping demand for cleaner energy and SSE's wind farms and hydropower could be a perfect solution. Renewables currently make up around 30% of profits but the plan is to treble renewable output by 2030 to 30 TWh a year (enough to power Scotland for a year).

So far so good, but there are challenges ahead.

Cash has been something SSE has found harder to come by in the past. It hasn't always generated enough to cover the multi-billion pound infrastructure bill and fund the dividend as well. The result has meant net debt has been trending up.

A moderate level of debt is no bad thing, especially for a business with such reliable revenues, but SSE can't keep borrowing forever. The scrip dividend, where dividends are paid in shares rather than cash, is helping to ease the burden, as are disposals. But neither are long-term solutions.

There are some external threats too. Tougher price regimes loom, as a new regulatory period is on the horizon. That has the potential to put pressure on margins. And whilst renewable energy is a growth sector, its returns are dependent on the unpredictable British weather.

Given the group's position as a 'bond proxy', it's worth mentioning interest rates also play into SSE's fate. They're low at the moment, but if we start to see increases, the appeal of dividend paying stocks like SSE is reduced, and the cost of the debt burden will increase as well.

All in we think SSE's focus on networks and renewables makes sense and probably goes a long way to explaining why the shares trade on 15.6 times expected future earnings, above a longer run average of 12. But there's more work to be done, particularly in turning around the cash position. For now, there's a prospective dividend yield of 5.5%.

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Third quarter trading details

SSE's Renewables output rose 6.3% to 6,934TWh in the first nine months of the financial year, around 5% lower than planned. Onshore wind output fell 5.0% to 3,026TWh, Offshore wind rose 61.5% to 1,487TWh, Hydro generation was 2,294TWh up 2.0% and Pumped storage fell to 127TWh, a drop of 24.4%.

The Networks business transported the same amount of electricity as last year at 28TWh.

Within Thermal Energy gas and oil fired output declined 18% to 12,321GWh and Coal output almost doubled to 1,003GWh. However, SSE is set to stop production at its last coal generation plant by March 2020 and continues to work on selling its gas production assets - although a sale won't be completed this financial year.

In December, SSE submitted its final Transmission business plan to Ofgem for the next regulatory period, which will cover April 2021 - March 2026. Proposals included total expenditure of £2.4bn which could bring the value of its regulated business (RAV) to over £5bn by 2026 - an increase from its current level of £3.4bn. Ofgem has said it'll publish its final view on the price control allowances at the end of this year.

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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.

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