When SSE faced calls from the activist investor Elliott Management for a break-up, the energy group argued there was strength in its diversity. The outbreak of the Ukraine war just months later helped vindicate the energy group, as prices soared and provided a windfall for its thermal power business. Flakey energy policies have highlighted the worth of SSE’s disparate businesses once again.
SSE has increased its capital expenditure target by £2.5 billion to around £20.5 billion until 2027. Projects in its regulated electricity transmission networks business have been approved by Ofgem. About £7.5 billion, or a third of the planned spending over the five-year period, will be put towards new transmission projects.
That investment is expected to increase the gross value of its regulated asset base to more than £10 billion by the end of 2027, almost double the current figure. For the networks business as a whole, which includes distribution, better scrutiny of spending prompted an increase in guidance for the regulatory asset value to more than £15 billion by 2027, up from a target of between £12 billion and £14 billion, and above the current value of £10.4 billion.
Growth in the value of SSE’s asset base should be reflected in the share price. SSE has outperformed pure-play wind farm operator Orsted over the past two years, which has become unstuck due to higher interest rates and cost inflation that has made projects uneconomical. Another reason SSE’s resistance to Elliott’s call to spin off its renewables arm has proven well-founded.
Clarity on capex plans in its networks business is more important given the wind auctions earlier this year were a flop. No companies bid to build new offshore wind projects. The maximum price was set at £44 per MWh, but that compared with £150/MWh in 2014. Energy operators’ financing costs have risen rapidly. Not surprisingly, the maximum price for next year has been raised to £73/MWh.
SSE has managed to balance higher investment alongside keeping its balance sheet in check. Net debt stood at £8.9 billion at the end of September, equivalent to a leverage multiple of 2.7, based upon last year’s earnings. This is below a target ceiling of between 3.5 and four. What’s more 92 per cent of that debt is effectively fixed, with an average cost of 4 per cent.
However, SSE is at the mercy of regulators and policymakers.
It has the largest renewable energy portfolio in Britain and Ireland, including the world’s largest offshore wind farm at Dogger Bank, Scotland’s deepest offshore wind farm at Seagreen and one of Europe’s largest onshore wind farms at Viking.
Potential projects are one thing, but there is growth to be extracted from its existing asset base. The energy group is targeting compound annual earnings growth of between 13 and 16 per cent until 2027. Of that, 95 per cent of earnings being targeted are set to come from assets that are either operational or where capital expenditure is committed.
It is making good progress. Earnings during the first half of the year came in ahead of consensus at 37p a share. There is scope for SSE to beat guidance again given earnings rise in the second half when cold weather increases energy usage.
The cost to investors of heightened capital expenditure has been a rebasing in the dividend, set to come in at 60p a share this year, and increased by 5 to 10 per cent each year until 2027. That leaves the shares offering a dividend yield of only 3.4 per cent at the current price. But if SSE can stay on budget and boost its asset value, then an appreciation in the shares could compensate for the loss of income.
Advice Buy
Why The shares could appreciate if spending plans remain on target
Warehouse Reit
The biggest challenge facing most real estate investment trusts is proving the validity of their valuations. For Warehouse Reit, the strength of its balance sheet has been the chief impediment to the shares recovering.
The warehouse landlord has sold more than £90 million in assets since November last year as it attempts to pay floating rate debt and cut burdensome finance costs. The latter more than doubled in the first half of the year to almost £13 million and weighed on earnings, which have failed to cover the dividend.
Like its peers, the shares trade at a steep discount to net tangible asset value, amounting to 32 per cent versus the end of September. That rises to 34 per cent against the NTA forecast by house broker Peel Hunt at the end of March.
In that context, the company is now looking to sell most, or all, of its stake in its Radway Green development, an asset not generating any income. The proceeds will be used to pay back the amount outstanding on its more expensive, £100 million revolving credit facility.
A refinancing of its debt facilities means 88 per cent of its debt is hedged against interest rate fluctuations, compared with 75 per cent over the last financial year. The sale of Radway should mean finance costs come down, and would also give a needed boost to liquidity. At the end of December it had drawn £285 million of its £320 million facilities. The cash cost of paying the 6.4p dividend being targeted this year is likely to amount to around £27 million alone.
The Reit is nearing the end of its planned disposals, with one more potentially on the cards. The trust’s investment manager then thinks it will be able to cover the dividend by the 2025 financial year.
The company is closing in on a target loan-to-value of 30 per cent, standing at 34 per cent at the end of September. Valuations are stable and the industrial landlord has managed to let space at an average 21.5 per cent ahead of previous contracted rents.
If the Reit can match progress on lettings with balance sheet strength then it could stand a better chance of closing the valuation gap.
Advice Hold
Why Strengthening the balance sheet should boost the share price
