Big six energy firm SSE (LSE: SSE) has been one of the biggest fallers in the FTSE 100 so far this year. It’s been a disappointing summer for shareholders, but I think news out today could prove to be a turning point for the firm.
Green light
One concern for investors has been uncertainty over whether the Competition and Markets Authority (CMA) would approve SSE’s plan to combine its retail business with that of Npower to form a new company.
In a report issued on Wednesday, the CMA approved the plan saying it’s “not expected to have a significant impact” on the pricing of the notorious Standard Variable Tariffs. SSE will now go ahead with the process of separating its energy retail business from its wholesale and network businesses.
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Why is this good news?
Like several of the other big six energy firms, SSE is losing retail customers to cheaper, smaller rival suppliers with fewer costs.
The financial logic of combining its business with a rival to create a larger and more focused operation always seemed good to me. SSE hasn’t yet provided numbers but says it expects to deliver “significant” cost savings by combining the two retail businesses.
SSE shareholders will receive shares in the new business. This means they will be able to choose whether to maintain their investment in the group’s energy retail business or sell the shares and enjoy a cash return.
The dividend question
About 80% of SSE’s profit comes from its networks and wholesale businesses, around which the company will be focused following the split. The board plans to cut the dividend by about 20% to 80p in 2019/20 to reflect the loss of retail profits.
At current levels, this forecast payout provides a generous forecast dividend yield of 7%. I expect the combined SSE/Npower retail business to also pay a dividend, so shareholders who keep both sets of shares will probably see a similar overall yield to that received at present.
Return to growth?
Personally, I’m more attracted to SSE as a pure infrastructure group. By focusing on gas and electricity production and distribution, I think investors should see greater benefit from the predictable cash flows generated by these regulated activities.
SSE is never going to become a growth stock. But the company can now focus on areas where there should be growth opportunities, such as renewable energy generation. Although this business isn’t without risk, I think the outlook is good.
What happens next?
The split isn’t expected to complete until late 2018/early 2019, so broker forecasts for the year to 31 March should still be valid. These show SSE trading on a forecast price/earnings ratio of 12, with a chunky 8.6% dividend yield.
The company has already confirmed its plans to make this dividend payment, so I’d be very surprised if it doesn’t go ahead. As I’ve already said, the yield is expected to fall to 7% in 2019/20. But this is still very high, and shareholders will also receive shares in the newly de-merged retail business.
Now that SSE’s future plans have been confirmed, I expect investor demand for this stock to improve. I think now could be a good time to buy.
