Questor share tip: SSE falls on Scottish 'yes' poll

SSE
£14.77-34p
Questor says HOLD

UTILITY group SSE [LON:SSE] was one of the leading fallers in the FTSE 100 yesterday as investors saw the Scottish-based power group’s profits taking a hit should the UK Government withdraw support for its wind farms in the event of the Yes campaign winning the Scottish referendum.

SSE is one of the UK’s big six energy providers and was formerly known as Scottish and Southern. Based in Perth, it now faces the prospect of losing millions in UK government support for its renewable energy projects if Scotland breaks away from the union.

The company has invested heavily in onshore and offshore wind farms and analysts estimate that those assets based in Scotland have a value of around £1.5bn.

Peter Atherton, analyst at Liberum, said the risk of a Yes vote was now material following a weekend opinion poll which showed a fractional, or 51pc, lead for the nationalists.

Wind farms are expensive to build and take a long time to return cash to investors. To encourage companies to invest in wind energy the UK Government agreed to subsidise them through renewable obligation certificates, or ROCs. These ROCs guarantee a set price in the market for energy produced from wind farms.

The UK Government has said it does not intend to automatically stand behind these subsidies for wind energy assets located in Scotland post separation.

A loss of the subsidies could bring a sharp fall to the cash SSE receives in payment for wind energy produced in Scotland. Mr Atherton estimates the current UK wholesale energy price is £56.50 per megawatt hour (MWh) almost half the subsidised level of about £97.50 per MWh that onshore wind energy currently receives with UK government help.

SSE generates £412m in revenue from its Scottish onshore wind portfolio and this contributes around £188m in profits. That makes up around 13pc of the group’s forecast full-year revenue of £31.2bn and 12pc of the £1.53bn pre-tax profits for March 2015. The revenue and profits from wind energy wouldn’t fall to nothing post separation, but Mr Atherton estimates that, should the subsidies be removed, it could lead to a 10pc downgrade in earnings per share in March 2017.

SSE shares are still having a good year despite yesterday’s setback. The shares are up more than 7pc in the year to date and the company said that it was still on track to deliver inflation-beating dividend increases at its first quarter trading update on July 17.

The power group said it will still increase dividends despite gas and electricity use falling and customer numbers declining by 100,000 to 8.99m at the end of June. The market is expecting a 3.7pc increase in the annual dividend to 89.9p, offering a 5.9pc prospective dividend yield on the shares.

The dividend payments at SSE are a major part of the company’s strategy. However they are now looking risky. The company is expected to make 119p in earnings per share in the 12 months to March 2015, and that only covers the 89.9p in forecast dividend payments 1.3 times. The dividends are also being paid out of debt, with the company forecast to generate around £200m in spare cash after spending on capital investment this year, which isn’t enough to cover the £670m in forecast dividends.

Net debts at SSE are expected to increase by about £600m to £8.25bn by March 2015, and that is more than twice the £3.23bn in shareholders equity.

The other risk to SSE investors is a Labour party that has made energy bills a major part of its election pledges. Should the party come to power next year, it could place serious strain on the future earnings.

SSE shares have had a strong start to the year, and now trade on an adjusted forecast ratio of 12.7 times earnings. The most attractive element is the forecast dividend yield of 6pc, and management has said the dividend growth will beat inflation for the foreseeable future.

The problem for investors is that the dividend payments are looking increasingly exposed as debts rise, and customers and energy usage fall. So, given the risks they are no better than a hold.