EUR 850.00 For Business Accounts Only

Morningstar | Tariff cap to hit structural profitability of SSE's retail business.

SSE’s profits are roughly evenly distributed between regulatory networks and liberalised power generation and energy supply activities. SSE’s wholesale generation unit operates roughly 11 gigawatts. We expect power generation to be the main earnings growth driver in the short and medium term on account of increasing power prices, capacity payments, and the commissioning of new wind and gas capacity. SSE's regulated electric and gas networks operate within a high-quality regulatory regime that allows it to generate value for shareholders. Regulatory risk is still an issue that investors should heed. The company's regulated networks have historically earned at or near their allowed returns. SSE is the second-largest retail energy supplier in the U.K. behind Centrica. This activity accounts for roughly one fifth of the group's operating profit. Against a challenging competitive and regulatory backdrop, SSE has decided to spin off this business and to merge it with Npower's retail arm. If cleared by the competition market authorities, or CMA, the deal should be completed by the first quarter of 2019. SSE's shareholders will receive one share of the new company for each share of SSE. We calculate that the deal will be roughly value-neutral, as synergies will be offset by poor profitability of Npower's retail arm. However, we think the move has a sound strategic rationale, as SSE will refocus on its core networks and power generation activities. We view SSE's diversified business profile as more appealing than pure regulated U.K. players United Utilities and National Grid as power generation mitigates networks' regulatory risk.SSE's dividend of GBX 80 per share in fiscal 2020 following the retail business spin-off constitutes a dividend yield of 5.8% based on our GBX 1,380 fair value estimate, above the 5.1% historical average. We view SSE shares as suitable for income-seekers.