SSE Investment Proposal (Original Presentation & Follow-Up)

1. SSE Investment Proposal
Slide 1
November 2013
SSE
UK Energy Market
Investment
Thesis
Inflation &
Politics
Market
Analysis
UK Energy
Market
SSE
Proposal

2. SSE Investment Proposal
Slide 2
November 2013
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
Inflation &
Politics
Market
Analysis
UK Energy
Market
SSE
Proposal

3. SSE Investment Proposal
Slide 3
November 2013
Investment Thesis
• 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
Inflation &
Politics
Market
Analysis
UK Energy
Market
SSE
Proposal

4. SSE Investment Proposal
Slide 4
November 2013
Inflationary impact
Source: BBC
Investment
Thesis
Inflation &
Politics
Market
Analysis
UK Energy
Market
SSE
Proposal

5. SSE Investment Proposal
Slide 5
November 2013
Inflationary impact
CPI inflation
Energy's contribution to CPI inflation
6
5
4
3
2
1
0
-1
Jan 2011
Jan 2012
Jan 2013
Source: Inflation Report, August 2013
Investment
Thesis
Inflation &
Politics
Market
Analysis
UK Energy
Market
SSE
Proposal

6. SSE Investment Proposal
Slide 6
November 2013
Political Situation
Investment
Thesis
Inflation &
Politics
Market
Analysis
UK Energy
Market
SSE
Proposal

7. SSE Investment Proposal
Slide 7
November 2013
Political Situation
Labour (Ed Miliband)
• Price freeze (20 months)
• Energy levies?
Conservatives (David Cameron)
• Reduce energy levy rises by 50%
• Upside risk
Investment
Thesis
Inflation &
Politics
Market
Analysis
UK Energy
Market
SSE
Proposal

8. SSE Investment Proposal
Slide 8
November 2013
Political Situation
Labour
Conservatives
UKIP
Liberal Democrats
Investment
Thesis
Inflation &
Politics
Market
Analysis
UK Energy
Market
SSE
Proposal

9. SSE Investment Proposal
Slide 9
November 2013
Market analysis
5%
contribution
from
government
schemes
8%
price
rise
3%
contribution
from
wholesale
energy prices
Investment
Thesis
Inflation &
Politics
Market
Analysis
UK Energy
Market
SSE
Proposal

10. SSE Investment Proposal
Slide 10
November 2013
Market analysis
UK Natural Gas Prices
80
75
70
65
Pence
per 60
therm
55
50
45
40
Jan-11
Investment
Thesis
Jan-12
Inflation &
Politics
Jan-13
Market
Analysis
Jan-14
UK Energy
Market
Jan-15
SSE
Jan-16
Proposal

11. SSE Investment Proposal
Slide 11
November 2013
UK Energy Market
UK Energy Supply Market Share (2009)
Others, 19%
Scottish
Power, 10%
British Gas, 18%
E.On, 18%
EDF, 10%
npower, 12%
SSE, 13%
Source: Nigel Tebbutt (Agiliti)
Investment
Thesis
Inflation &
Politics
Market
Analysis
UK Energy
Market
SSE
Proposal

12. SSE Investment Proposal
Slide 12
November 2013
UK Energy Market
UK revenues as a percentage of company totals
100%
97.94%
80%
71%
60%
40%
28%
18%
20%
15%
8%
0%
SSE
Investment
Thesis
Centrica
(British Gas)
Inflation &
Politics
IBERDROLA
(Scottish
Power)
Market
Analysis
RWE (npower)
EDF
E.On
UK Energy
Market
SSE
Proposal

13. SSE Investment Proposal
Slide 13
November 2013
UK Energy Market
Market capitalisation ($bn)
80
74.2
70
63.6
60
50
40
30
29.4
21.0
22.5
RWE (npower)
SSE
32.9
20
10
0
Centrica (British E.On AG (E.On)
Gas)
EDF
IBERDROLA
(Scottish
Power)
SSE
Proposal
Source: Hoovers
Investment
Thesis
Inflation &
Politics
Market
Analysis
UK Energy
Market

14. SSE Investment Proposal
Slide 14
November 2013
UK Energy Market
P/E ratios (2012)
30
28.09
25
20
16.67
14.14
15
10.74
IBERDROLA
(Scottish
Power)
10
9.80
E.On AG (E.On)
14.56
5
0
EDF
RWE (npower) Centrica (British
Gas)
SSE
Source: Hoovers
Investment
Thesis
Inflation &
Politics
Market
Analysis
UK Energy
Market
SSE
Proposal

15. SSE Investment Proposal
Slide 15
November 2013
Share Performance
Source: Yahoo Finance (4/11/13)
Investment
Thesis
Inflation &
Politics
Market
Analysis
UK Energy
Market
SSE
Proposal

16. SSE Investment Proposal
Slide 16
November 2013
Share Performance
Price freeze proposed
Source: Yahoo Finance (1/11/13)
Investment
Thesis
Inflation &
Politics
Market
Analysis
UK Energy
Market
SSE
Proposal

17. SSE Investment Proposal
Slide 17
November 2013
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
Inflation &
Politics
Market
Analysis
UK Energy
Market
SSE
Proposal

18. SSE Investment Proposal
Slide 18
November 2013
Financial Analysis
Analyst's Target Prices
£21
£20
£19.33
£19
£18
£17.00
£17
£16.00
£16
£13.95
£14
£12
Merrill
Lynch
HSBC
£14.75
£15
£13
£16.10
£12.56
£14.00
£12.70
£12.00
£11
JPMorgan
Investment
Thesis
Worst
case
Citigroup Current Deutsche Investec
price
Bank
Inflation &
Politics
Market
Analysis
UK Energy
Market
SSE
Credit
Suisse
Probable
case
Proposal

19. SSE Investment Proposal
Slide 19
November 2013
Risks
DISCOUNT RATE (WACC)
£
19
C
A
S
H
F
L
O
W
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
N/A
£
88.32
£
39.48
£
27.37
£
23.22
£ 15.09
£
10.22
3.25%
↑
3%
N/A
£
184.15
£
55.15
£
35.45
£
29.37
£ 18.32
£
12.20
3.5%
N/A
£
86.49
£
48.40
£
38.59
£ 22.63
£
14.66
Investment
Thesis
Inflation &
Politics
N/A
Market
Analysis
UK Energy
Market
SSE
Proposal

20. SSE Investment Proposal
Slide 20
November 2013
Risks
DISCOUNT RATE (WACC)
3.0%
C
O
S
T
R
I
S
E
S
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
Inflation &
Politics
Market
Analysis
UK Energy
Market
SSE
Proposal

21. SSE Investment Proposal
Slide 21
November 2013
Risks
Risk
Discount rate rises
Why it won’t be realised
• 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
Inflation &
Politics
Market
Analysis
UK Energy
Market
SSE
Proposal

22. SSE Investment Proposal
Slide 22
November 2013
Proposal
• Buy SSE stock
– Target price of £18.50
– Time horizon: sale before May 2015
• No hedging
Investment
Thesis
Inflation &
Politics
Market
Analysis
UK Energy
Market
SSE
Proposal

23. SSE Investment Proposal Follow-Up
Slide 1
November 2013
SSE
UK Energy Market
Investment Thesis
Industry profitability
Exchange rate
Proposal

24. SSE Investment Proposal Follow-Up
Slide 2
November 2013
Investment Thesis
• 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
Industry profitability
Exchange rate
Proposal

25. SSE Investment Proposal Follow-Up
Slide 3
November 2013
Industry profitability
Projected P/E ratios for current FY
16
13.9
14
12.6
11.7
12
11.7
SSE
IBERDROLA
(Scottish Power)
10.9
10
8
6.8
6
4
2
0
RWE (npower)
Investment Thesis
E.On AG
Industry profitability
Exchange rate
Centrica
(British Gas)
EDF
Proposal

26. SSE Investment Proposal Follow-Up
Slide 4
November 2013
Industry profitability
P/B ratios
3.5
3.1
3
2.4
2.5
2
1.4
1.5
1
1.5
0.9
0.7
0.5
0
E.On AG
Investment Thesis
IBERDROLA
(Scottish Power)
EDF
Industry profitability
RWE (npower)
Exchange rate
SSE
Centrica
(British Gas)
Proposal

27. SSE Investment Proposal Follow-Up
Slide 5
November 2013
Proposal
• Buy SSE stock
– Target price of £18.50
– Time horizon: sale before May 2015
• No hedging
Investment Thesis
Industry profitability
Exchange rate
Proposal

28. SSE Investment Proposal Follow-Up
Slide 6
November 2013
Exchange rates
Trade weighted sterling exchange rate (January 2005 = 100)
Spot sterling/USD exchange rate
100
2.1
2
95
1.9
Trade
weighted
exchange
rate (January
2005 = 100)
90
1.8
85
1.7 $ per £
1.6
80
1.5
75
1.4
70
1.3
Source: Bank of England
Investment Thesis
Industry profitability
Exchange rate
Proposal

29. SSE Investment Proposal Follow-Up
Slide 7
November 2013
Exchange rates
Trade weighted sterling exchange rate (January 2005 = 100)
Spot sterling/USD exchange rate
84
1.65
83
82
1.6
$ per £
Trade
81
weighted
exchange 80
rate (January
2005 = 100) 79
1.55
78
1.5
77
76
01-May-13
Source: Bank of England
Investment Thesis
1.45
01-Jun-13
01-Jul-13
01-Aug-13
Industry profitability
01-Sep-13
01-Oct-13
Exchange rate
01-Nov-13
Proposal

30. SSE Investment Proposal Follow-Up
Slide 8
November 2013
Exchange rates
• Inflation
• Interest rates
• Economic performance
Investment Thesis
Industry profitability
Exchange rate
Proposal

31. SSE Investment Proposal Follow-Up
Slide 9
November 2013
US Inflation Forecast
Source: Federal Reserve
Investment Thesis
Industry profitability
Exchange rate
Proposal

32. SSE Investment Proposal Follow-Up
Slide 10
November 2013
UK Inflation Forecast
Source: Bank of England
Investment Thesis
Modelling assumptions: market interest rates & constant nominal value of asset purchases at £375bn
Industry profitability
Exchange rate
Proposal

33. SSE Investment Proposal Follow-Up
Slide 11
November 2013
Forward Guidance
US
UK
• Federal funds rate of 00.25% “appropriate” as long
as
• Bank rate at 0.5% “at least
until” unemployment fallen
to “threshold” of 7%
• 3 knockouts
– Unemployment rate above
6.5%
– Inflation projected above
2.5% in 1-2 years
– Long term inflation
expectations rise
Investment Thesis
Industry profitability
– CPI more likely above 2.5% in
18-24 months
– Medium term inflation
expectations not well
anchored
– Risk to financial stability
Exchange rate
Proposal

34. SSE Investment Proposal Follow-Up
Slide 12
November 2013
US Unemployment Rate Forecast
Source: Federal Reserve
Investment Thesis
Industry profitability
Exchange rate
Proposal

35. SSE Investment Proposal Follow-Up
Slide 13
November 2013
US Interest Rate Forecast
Source: Federal Reserve
Investment Thesis
Industry profitability
Exchange rate
Proposal

36. SSE Investment Proposal Follow-Up
Slide 14
November 2013
UK Unemployment Rate Forecast
Source: Bank of England
Investment Thesis
Modelling assumptions: market interest rates & constant nominal value of asset purchases at £375bn
Industry profitability
Exchange rate
Proposal

37. SSE Investment Proposal Follow-Up
Slide 15
November 2013
UK Unemployment Threshold Forecast
Cumulative
probability of
unemployment
having fallen below
the 7% threshold
Source: Bank of England
Investment Thesis
Industry profitability
Exchange rate
Proposal

38. SSE Investment Proposal Follow-Up
Slide 16
November 2013
US Economic Growth Forecast
Source: Federal Reserve
Investment Thesis
Industry profitability
Exchange rate
Proposal

39. SSE Investment Proposal Follow-Up
Slide 17
November 2013
UK Economic Growth Forecast
Source: Bank of England
Investment Thesis
Modelling assumptions: market interest rates & constant nominal value of asset purchases at £375bn
Industry profitability
Exchange rate
Proposal

40. SSE Investment Proposal Follow-Up
Slide 18
November 2013
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
Investment Thesis
Industry profitability
Exchange rate
Proposal

41. SSE Investment Proposal Follow-Up
Slide 19
November 2013
Exchange rates
£ per $
1.65
1.6
1.55
1 month
6 months
1 year
Analyst
Expectations
1.6024
1.5916
-
-
Futures
Curves
1.5
3 months
1.5924
1.5916
1.5904
1.5878
1.45
01-Jan-13
01-Jul-13
01-Jan-14
01-Jul-14
01-Jan-15
Source: Bank of England
Investment Thesis
Industry profitability
Exchange rate
Proposal

42. SSE Investment Proposal Follow-Up
Slide 20
November 2013
Proposal
• Buy SSE stock
– Target price of £18.50
– Time horizon: sale before May 2015
• No hedging
Investment Thesis
Industry profitability
Exchange rate
Proposal