SSE (SSE) announced that it will spin off its SSE Retail unit with Innogy's Npower to create a separate publicly traded UK energy company, which will have a market share of 22.5% of gas and electricity customers, rivalling British Gas' 27% share. The move will reduce the “big six” energy suppliers, which will be subject to energy price caps from 2019, to five. We view the combination as positive for shareholders, as the efficiency benefits from the joint operations would likely be significant.
SSE shareholders would hold 65.6% of the new entity. Germany’s Innogy (IGY) has been looking at ways to offload the unprofitable npower, and SSE has been trying to stem customer losses amid a competitive retail environment.
We don't incorporate the announcement into our fair value estimate yet as we expect the transaction will likely come under significant competitive scrutiny from the Competition and Markets Authority (CMA).
We are reaffirming our £15.80 per share fair value estimate, and narrow economic moat rating, which means the company has a slender competitive advantage, after SSE reported adjusted first-half operating results of £586 million, down 8% from the same period a year ago. The interim dividend increased 3.6% to 28.4 pence.
Energy Suppliers Under Intense Scrutiny
While trading at a 10% discount to our fair value estimate, we urge caution as SSE is coming under heightened political and regulatory scrutiny. The government published draft legislation last month that would allow UK regulator Ofgem the ability to cap standard variable tariffs. The outcome of the government potentially capping energy tariff prices, which has many customers by default on higher retail rates than otherwise available, is unknown and could materially lower our fair value estimate depending on the outcome.
The company's mix of regulated utility operations, merchant power plants, and other noncore operations maintain solid market positions but remain subject to commodity price volatility and market entrants. Regulated utilities in Europe maintain narrow moats because of the implicit contract between regulators and capital providers that seeks to maximise investor returns while minimising customer rates. SSE's merchant energy operations have weaker economic moats because of their sensitivity to worldwide commodity markets. We assign no-moat ratings to retail energy businesses like SSE's because of the low barriers to entry and intense price competition.
