Berenberg upgrades SSE as it highlights sector-topping dividend yield

Berenberg upgraded SSE to ‘buy’ from ‘neutral’ as it believes that the utility’s sector-topping 6.5% yield and promise of retail price index (RPI) linked dividend growth is sustainable.

The bank also said debt ratios are manageable and will reduce, political risk in the UK is “overplayed”, and that the risk to power prices in the wholesale market is skewed to the upside.

The broker increased its price target to 1,650p per share from 1,550p , an 11% potential upside and a 17% 12-month total return.

It said that the 6.5% yield and RPI-linked dividend policy is the highest dividend yield in the sector - the average being 5.1% - “from a company for which the dividend is sacrosanct”.

Berenberg expects the company's philosophy of putting the sustainability of its dividend at the forefront of its shareholder proposition for the foreseeable future and thinks that capital expenditure growth will give before the dividend if balance sheet pressure needs to be eased.

It forecasts a dividend cover remaining within SSE’s 1.2-1.4 times range over the next three years.

An expected net debt to earnings before interest, tax, depreciation and amortisation (EBITDA) ratio of 4.3 times in 2017/18 is “a little high” for Berenberg, even for a company with about 60% regulated or quasi-regulated EBITDA, but it believes that this will be the peak.

A reduction in capital expenditure growth is expected to help reduce leverage to below four times in subsequent years, avoiding disruption to the dividend.

The broker maintained that political risk is“overplayed” as the “heavy-handed intervention in the supply market would be unnecessary and, frankly, a bad idea” and that political meddling, such as a price cap, would be bad for competition, customers and investment in the economy.

“Undermining the findings of the Competition and Markets Authority would have negative ramifications well beyond the bounds of the most recent probe into the energy supply market. Politics will always feature in this sector. Nonetheless, we continue to expect common sense will prevail when it comes to actual intervention.”

In addition, Berenberg said that the tight reserve margin and a hiatus in new capacity investment could remain a potentially inflationary feature of the UK power market for some time, especially if the government presses ahead with plans to phase out coal and start to close old nuclear power stations by 2025, while Brexit also puts currency pressure on price-setting thermal generation costs.

Shares in SSE were down 0.06% to 1,480.05p at 0802 BST.