Comments from politicians inferring that the government should freeze energy prices have sent a chill through utility companies and SSE (LSE: SSE) (NASDAQOTH: SSEZY.US) is no different.
Still, for the most part these fears have been dismissed as a desperate bid for votes in the run-up to the general election. That said, evidence is now starting to emerge, which suggests that SSE is at risk from other factors not just a potential price freeze.
Political power play
In particular, it has been suggested by some City analysts that UK power bills will need to rise by £40 per household to compensate for falling consumption and rising costs this year. However, increasing energy bills just months before a general election would be politically damaging and it is unlikely that companies will be allowed to increase prices.
Unfortunately, this would mean that utility providers would have little time to increase energy prices substantially before the next government moved in and froze prices. What’s more, while some have claimed that the promise to freeze energy bills was just a political power play, there is actually evidence to suggest that UK energy bills are too high.
Indeed, SSE claims to make a profit margin of between 5% and 6% from retail customers. Within Europe this margin is 2% to 3% and many believe there is no reason why SSE cannot move back to this level.
Squeezed for cash
That said, if SSE’s retail profit margin fell to the level above, the company would be in dire straits. For example, SSE reported a profit of £410 million from its retail operations during its 2013 financial year. A 50% cut in profit from retail operations could reduce this to £205 million.
To put this in some perspective, during 2013 SSE’s dividend payout cost a total of £515 million.
With this being the case, some City analysts now believe that a dividend cut is on the cards for SSE in the near future. Moreover, some analysts are even speculating that if a price freeze came into effect, SSE would be in danger of breaching its banking convents and the company would need to tap the market for cash to fund its operations — this implies that SSE could be forced to undertake a rights issue.
Foolish summary
In conclusion, with the general election taking place next year, SSE is unlikely to be able to raise energy bills in order to offset rising costs. While this is not a problem in itself, if the next government freezes energy prices, SSE could quickly run out of cash and a dividend cut, or cash call will be on the cards.
