sse

SSE

UK Energy Market

SSE Investment Proposal Slide 1 November 2013

Investment Thesis

Inflation & Politics

Market Analysis

UK Energy Market SSE Proposal

SSE

• Integrated energy firm– Retail (c. 25% of revenue)– Transmission & distribution (almost no revenue)– Generation & wholesale (c. 75% of revenue)

• By profit, retail has become most important• Listed on FTSE 100 (SSE.L)

Investment Thesis


Market Analysis



• Impact of retail price freeze is overestimated– Energy levies won’t increase as far– Wholesale gas prices likely to fall– Possible Conservative coalition or victory

• Hence, SSE is undervalued

Investment Thesis


Market Analysis


Investment ThesisSSE Investment Proposal Slide 3 November 2013

Source: BBC

Inflationary impact

Investment Thesis


Market Analysis



Jan 2011 Jan 2012 Jan 2013-1

0

1

2

3

4

5

6

CPI inflationEnergy's contribution to CPI inflation

Source: Inflation Report, August 2013

Inflationary impact

Investment Thesis


Market Analysis



Political Situation

Investment Thesis


Market Analysis



Political Situation

Labour (Ed Miliband)• Price freeze (20 months)• Energy levies?Conservatives (David Cameron)• Reduce energy levy rises by 50%• Upside risk

Investment Thesis


Market Analysis



Political Situation

Investment Thesis


Market Analysis



Labour

Conservatives

UKIP

Liberal Democrats

Market analysis

5% contribution from government

schemes

3% contribution from wholesale energy prices

8% price rise

Investment Thesis


Market Analysis



Market analysis

Jan-11

Apr-11Ju

l-11

Nov-11

Feb-12

Jun-12

Sep-12

Jan-13

Apr-13

Aug-13

Nov-13

Mar-

14

Jun-14

Sep-14

Jan-15

Apr-15

Aug-15

Nov-15

Mar-

16

Jun-16

Oct-16

40

45

50

55

60

65

70

75

80

UK Natural Gas Prices

Pence per

therm

Investment Thesis


Market Analysis



Source: Nigel Tebbutt (Agiliti)

UK Energy Market

Investment Thesis


Market Analysis


British Gas; 18%

E.On; 18%

SSE; 13%

npower; 12%

EDF; 10%

Scottish Power; 10%

Others; 19%

UK Energy Supply Market Share (2009)


SSE

Centri

ca (B

ritish

Gas)

IBERDROLA

(Sco

ttish Power)

RWE (

npower) EDF

E.On

0%

20%

40%

60%

80%

100% 98%

71%

28%18% 15%

8%

UK revenues as a percentage of company totals

UK Energy Market

Investment Thesis


Market Analysis



UK Energy Market

RWE (

npower) SSE

Centri

ca (B

ritish

Gas)

E.On AG (E

.On)

EDF

IBERDROLA

(Sco

ttish Power)

01020304050607080

21.0 22.529.4 32.9

63.674.2

Market capitalisation ($bn)

Source: Hoovers

Investment Thesis


Market Analysis



UK Energy Market

IBERDROLA

(Sco

ttish Power)

E.On AG (E

.On)

EDF

RWE (

npower)

Centri

ca (B

ritish

Gas) SSE

0

5

10

15

20

25

30

9.8 10.7414.14 14.56

16.67

28.09

P/E ratios (2012)

Source: Hoovers

Investment Thesis


Market Analysis



Share Performance

Source: Yahoo Finance (4/11/13)

Investment Thesis


Market Analysis



Share Performance

Source: Yahoo Finance (1/11/13)

Price freeze proposed

Investment Thesis


Market Analysis



Financial Analysis (DCF)

Probable case Worst case

Price freeze implemented from May 2015 to end of 2016

Revenues rise at historical average (in line with analyst expectations)

Gas prices fall 2% year-on-year Gas prices rise at historical average

Environmental policy requirements contribute 2.5 percentage points to

price rises

Environmental policy requirements continue to contribute 5 percentage

points to price rises

£19.33 £12.56

Investment Thesis


Market Analysis



Financial Analysis

Investment Thesis


Market Analysis


JPMorgan

Worst

case

Citigroup

Current p

rice

Deutsche Bank

Investec

Merrill L

ynchHSBC

Credit Suiss

e

Probable ca

se £11

£12

£13

£14

£15

£16

£17

£18

£19

£20

£21

£12.00 £12.56 £12.70

£13.95 £14.00 £14.75

£16.00 £16.10 £17.00

£19.33

Analyst's Target Prices


Risks

£ 19 3.0% 3.5% 4.0% Actual (4.3%) 4.5% 5.0% 5.5%

1.5% £ 25.06 £ 16.44 £ 11.28 £ 8.88 £ 7.85 £ 5.40 £ 3.57

1.75% £ 31.57 £ 19.87 £ 13.37 £ 10.47 £ 9.25 £ 6.39 £ 4.31

2% £ 41.34 £ 24.43 £ 15.98 £ 12.40 £ 10.92 £ 7.55 £ 5.15

2.25% £ 57.63 £ 30.82 £ 19.34 £ 14.79 £ 12.97 £ 8.92 £ 6.13

Actual (2.6%) £ 114.63 £ 45.73 £ 26.06 £ 19.33 £ 16.75 £ 11.32 £ 7.78

2.75% £ 187.91 £ 56.38 £ 30.08 £ 21.85 £ 18.83 £ 12.58 £ 8.61

3% N/A £ 88.32 £ 39.48 £ 27.37 £ 23.22 £ 15.09 £ 10.22

3.25% N/A £ 184.15 £ 55.15 £ 35.45 £ 29.37 £ 18.32 £ 12.20

3.5% N/A N/A £ 86.49 £ 48.40 £ 38.59 £ 22.63 £ 14.66

Investment Thesis


Market Analysis



DISCOUNT RATE (WACC)

CASH

FLOW

↑

Risks

3.0% 3.5% 4.0% Actual (4.3%) 4.5% 5.0% 5.5%

7.7% £ 182.63 £ 75.64 £ 45.08 £ 34.60 £ 30.62 £ 22.20 £ 16.68

7.8% £ 148.69 £ 60.71 £ 35.59 £ 26.97 £ 23.70 £ 16.77 £ 12.24

Actual (7.9%) £ 114.63 £ 45.73 £ 26.06 £ 19.33 £ 16.75 £ 11.32 £ 7.78

8.0% £ 80.43 £ 30.69 £ 16.49 £ 16.49 £ 9.77 £ 5.86 £ 3.30

8.1% £ 46.11 £ 15.60 £ 6.89 £ 6.89 £ 2.77 £ 0.37 -£ 1.20

8.2% £ 11.67 £ 0.45 -£ 2.75 -£ 2.75 -£ 4.26 -£ 5.13 -£ 5.71

Investment Thesis


Market Analysis



DISCOUNT RATE (WACC)

COST

RISES

Risks

Risk Why it won’t be realised

Discount rate rises • MPC forward guidance• MPC July statement against yield rises

Gas prices don’t fall • Only matters during price freeze window

Politics • Pressure of Cameron’s energy levy policy• Cameron has rebuffed windfall tax idea

Blackouts • California: faulty market design, capacity, regulatory inaction & market manipulation

Investment Thesis


Market Analysis



Proposal

• Buy SSE stock– Target price of £18.50– Time horizon: sale before May 2015

• No hedging

Investment Thesis


Market Analysis



SSE

UK Energy Market

Investment Thesis Industry profitability Exchange rate Proposal

SSE Investment Proposal Follow-Up Slide 1 November 2013

• Impact of retail price freeze is overestimated– Energy levies won’t increase as far– Wholesale gas prices likely to fall– Possible Conservative coalition or victory

• Hence, SSE is undervalued

Investment ThesisSSE Investment Proposal Follow-Up Slide 2 November 2013


Industry profitabilitySSE Investment Proposal Follow-Up Slide 3 November 2013

RWE (npower) E.On AG SSE IBERDROLA (Scottish Power)

Centrica (British Gas)

EDF0

2

4

6

8

10

12

14

16

6.8

10.911.7 11.7

12.6

13.9

Projected P/E ratios for current FY


Industry profitabilitySSE Investment Proposal Follow-Up Slide 4 November 2013

E.On AG IBERDROLA (Scottish Power)

EDF RWE (npower) SSE Centrica (British Gas)

0

0.5

1

1.5

2

2.5

3

3.5

0.7000000000000010.9

1.4 1.5

2.4

3.1

P/B ratios


Proposal


• No hedging



Exchange rates

01-Jan-08

15-Apr-0

8

29-Jul-0

8

11-Nov-08

24-Feb-09

09-Jun-09

22-Sep-09

05-Jan-10

20-Apr-1

0

03-Aug-10

16-Nov-10

01-Mar-1

1

14-Jun-11

27-Sep-11

10-Jan-12

24-Apr-1

2

07-Aug-12

20-Nov-12

05-Mar-1

3

18-Jun-13

01-Oct-

1370

75

80

85

90

95

100

1.3

1.4

1.5

1.6

1.7

1.8

1.9

2

2.1

Trade weighted sterling exchange rate (January 2005 = 100)Spot sterling/USD exchange rate

Trade weighted exchange

rate (January 2005 = 100)

$ per £

Source: Bank of England



Exchange rates

01-May-13 01-Jun-13 01-Jul-13 01-Aug-13 01-Sep-13 01-Oct-13 01-Nov-1376

77

78

79

80

81

82

83

84

1.45

1.5

1.55

1.6

1.65

Trade weighted sterling exchange rate (January 2005 = 100)Spot sterling/USD exchange rate

Trade weighted exchange

rate (January 2005 = 100)

$ per £




Exchange rates

• Inflation• Interest rates• Economic performance



US Inflation Forecast

Source: Federal Reserve



UK Inflation Forecast




Modelling assumptions: market interest rates & constant nominal value of asset purchases at £375bn

Forward GuidanceUS• Federal funds rate of 0-

0.25% “appropriate” as long as– Unemployment rate above

6.5%– Inflation projected above

2.5% in 1-2 years– Long term inflation

expectations rise

UK• Bank rate at 0.5% “at least

until” unemployment fallen to “threshold” of 7%

• 3 knockouts– CPI more likely above 2.5% in

18-24 months– Medium term inflation

expectations not well anchored

– Risk to financial stability



US Unemployment Rate Forecast




US Interest Rate Forecast




UK Unemployment Rate Forecast





Cumulative probability of unemployment having fallen below the 7% threshold




UK Unemployment Threshold Forecast

US Economic Growth Forecast




UK Economic Growth Forecast





Exchange rate• Higher inflation in UK (£ depreciates)• Similar interest rates• Lower economic growth in UK (£ depreciates)

• All to a small extent

• Slight risk of £ depreciating, reducing value of investment



Exchange rates




01-Jan-13 01-Jul-13 01-Jan-14 01-Jul-14 01-Jan-151.45

1.5

1.55

1.6

1.65

£ per $

1 month 3 months 6 months 1 year

Analyst Expectations 1.6024 1.5916 - -

Futures Curves 1.5924 1.5916 1.5904 1.5878

Proposal


• No hedging



sse

Business

sse investment proposalslide

energy levy

onuk energy marketsseproposal

investment thesisjan

uk energy marketjan

uk energy market uk

months energy levies

uk energy market pe