EUR 850.00 For Business Accounts Only

Morningstar | SSE Sets Full-Year EPS Guidance in Line With Our Estimates; Shares Undervalued

We reiterate our fair value estimate of GBX 1,380 per share for SSE along with our narrow moat and stable trend ratings after the group released half-year results and set full-year EPS guidance in line with our and consensus expectations. We believe the uncertainty from new hurdles to the energy services spin-off is offset by undervaluation of the shares, offering an attractive reward/risk profile.

Adjusted operating profit in 2018-19's first half fell 24% to GBP 448 million. This is less bad than September's profit warning guiding for a 50% fall. The wholesale business was break-even versus profit warning guidance of an operating loss as the energy portfolio management unit reported an adjusted operating loss of GBP 86 million versus GBP 100 million guided at the profit warning. For the full year, the group now guides for an operating loss of around GBP 300 million, in line with our estimate, versus in excess of GBP 300 million previously. In line with the profit warning, total retail's operating profit was break-even as the losses of energy services were offset by the retail business. For household supply, SSE guides for a full-year operating margin of 2%-3% versus our 3.5% outlook. The group set guidance of adjusted EPS in a GBX 70-75 range for the full year, in line with our GBX 72 estimate and consensus' GBX 73.

For the 2019-20 fiscal year, the group indicates that energy portfolio management's losses will persist due to a short gas position against increasing gas prices. This loss will amount to around GBP 115 million versus our break-even assumption. Further out, the business is expected to generate a small profit. Regarding energy services, the group guides for margins further lower in 2019-20 due to the default tariff cap versus our 1% margin assumption, which might be too conservative. All in all, we should reduce our 2019-20 EPS, but that will have no impact on our long-term estimates.

On Nov. 8, Innogy and SSE decided to enter into negotiations to adjust the terms of the merger of their respective U.K. retail arms. An update of the discussions should be provided by mid-December, and the merger will probably be delayed beyond the first quarter of 2019, according to SSE. The reason for these "adjustments" is the pressure from credit rating agencies requiring the new company to post higher collateral to obtain and retain an ''appropriate credit rating'' against a tough backdrop marked by the default tariff cap and high commodity cost increases over the last months. That evidences the structural weakness of a pure retail player and should have been anticipated by respective managements. So far, we have calculated that the deal would be value-neutral for SSE as synergies will be offset by poor profitability of Innogy's U.K. retail arm, Npower. In all, additional cash injections would be value-destructive for SSE, which is due to have a 66% stake in the new company. Should the deal be eventually scrapped, that would further dent SSE management's credibility.