SSE plc’s 2 Greatest Weaknesses

When I think of electricity and gas utility company SSE (LSE: SSE) (NASDAQOTH:SSEZY.US), two factors jump out at me as the firm’s greatest weaknesses and top the list of what makes the company less attractive as an investment proposition.

1) Fierce regulation

SSE kicked off its recent interim management statement by saying that it focuses on working with customers, politicians, regulators and other stakeholders to ensure it fulfills its core purpose, which is to provide the energy people need in a reliable and sustainable way.

centrica / sseWith a statement like that, it’s clear how many vested interests are involved in the firm’s operations and why the regulatory environment for utility companies is so fierce. As a member of the utility using public I’m pleased about that, but as a potential shareholder I’m aware that such a regime crimps the firm’s ability to expand at will, maximise profits and generally to do all that it can to optimise my returns. Indeed, recent news that the firm plans to freeze its customers’ energy bills until 2016 seems to prove the point.

2) Capital-intensive operations

Generating, drilling for, moving, distributing, and supplying energy, in any form, involves huge capital investment in infrastructure assets that need to be installed, maintained and improved. That’s one reason why utilities are public limited companies in the first place – they need investors’ money. But it’s not enough, so firms like SSE turn to that other ubiquitous source of finance, debt, too.

Investment in infrastructure is one of the things that regulators regulate. There’s no ‘running the assets hot’ Tesco-style, for example. SSE is pretty much told when and how much to invest and that means much of the firm’s earnings go to debt financing and not to share holders. So, it’s important to keep an eye on the firm’s debt-levels as they compete with investors for the bucks the firm manages to squeeze from its operations:

Year to   March 2009 2010 2011 2012 2013
Net debt (£m) 5,100 5,785 5,130 6,056 5,546
Operating profit (£m) 106 1,794 2,302 394 670
Debt divided by profit 48 3 2 15 8

Comparing debt-levels to operating profits provides some perspective to judge the size of the debt-burden. I’m looking forward to seeing how the company is performing on debt when it updates the market with its full-year results due around 21 May.

What now?

Despite such concerns, SSE’s forward dividend yield is running at an attractive 6.6% for 2016.

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Kevin does not own any SSE shares. The Motley Fool owns shares in Tesco.