HSBC upgrades SSE as earning potential rises

HSBC upgraded energy company SSE to ‘buy’ from ‘hold’ and raised its price target to 1,740p from 1,660p due to good visibility on earnings.

Earnings visibility from regulated networks indexed to higher retail price index (RPI) and capacity payments indicated "favourable weather" for the company.

The group’s diverse generation portfolio has an increasing portion of regulated support. Electricity transmission and distribution investment underpinned by a regulated price control is linked to growing RPI.

The bank does however feel the company’s 100 base point yield premium to the sector is "unjustified".

Investors are cautious about the presentation of earnings and the use of hybrid debt and scrip dividends which dilute earnings and overstate dividend cover, according to analysts.

The most significant event last year for HSBC was Moody’s decision to affirm a Baa1/Stable outlook in October.

A "key threat" to the company is that it has the highest number of retail customers remaining on the Standard and Variable Tariff of any supply company at 91%, making it more vulnerable to further customer losses.

The bank has assigned a 50% weight to yield and 25% each to discounted cash flow (DCF) and sum-of-the-parts (SOTP)/peer group to arrive at its new rounded target price of 1,740p.

It has made more “aggressive assumptions” on the DCF valuation which has increased the cost of capital valuations to 4.5% to 4.2%. These are offset by the analyst’s increase in yield valuation due to a reduction in dividend yield valuation to 5.25% from 6%.

The share price was up 0.66% to 1,518p at 0939 GMT on Wednesday.