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07 July 2021

Riding the Wave

It has become well accepted across the wide spectrum of market commentators that a wave of inflation is approaching. The question remains, however, as to whether this is to be a transitory phase or a return to 1970s-esque price pressures.

Inflation is often stigmatised as a critical danger by investors. While it certainly presents challenges and difficulties which one must navigate, it also offers investors opportunities and the chance to ride the inflationary wave towards achieving higher cash flows and returns.

Thus, the key is searching for the sectors and securities with cashflows intrinsically linked to inflation. Based in the UK, we lie at the heart of the megatrend that is the push towards green-energy and a carbon-neutral future, with the majority of global offshore wind projects structured around our shores.

It is refreshing not to be forced to look towards US markets for exposure to a global macroeconomic megatrend shaping the future investment horizon. America may have the FAANGs (Facebook, Apple, Amazon, Netflix, and Google), but Europe can boast about the ORIS (Orsted, RWE, Iberdrola, and SSE) with the continent leading the race towards achieving carbon-neutrality.

SSE, formerly known as Scottish and Southern Energy, is a utilities company which owns energy networks, wind farms and gas-fired power plants and supplies gas and electricity to businesses. Fundamentally, the company has announced that its dividend-per-share, the cashflow investors receive from holding the shares, will grow in line with inflation until 2023.

Alongside the contractual nature and inflation-linkage of such agreements, SSE has a thematic and structural tailwind driving expectations for future returns. The company is the world’s largest producer of offshore wind facilities and, by developing renewable energy generation capacity and investing in the networks that will be essential for the electrification of the economy, lies at the crux of the Government’s ambition of achieving net-zero carbon emissions by 2050.

SSE has interests in Dogger Bank in the North Sea, which will be the world’s largest offshore wind farm when completed, concurrently developing Scotland’s largest offshore wind farm in Angus. In addition, SSE is backing other forms of low-carbon power generation including carbon capture and hydrogen as an alternative to natural gas.

The business is rapidly transitioning away from fossil fuels towards cleaner energies. Asset sales are helping to fund this shift, as it aims to treble its renewable energy generation capacity by 2030. As recently as May, SSE announced that it was putting its 33.3% stake in the UK gas distribution business Scotia Gas Networks (SGN) up for sale, and analysts expect between £1bn and £1.1bn to be raised from the sale. This comes off the back of offloading its household energy supply business to Ovo Energy last year and selling its North Sea gas fields.

Although SSE’s diversified business profile makes the company more attractive than pure-play UK utilities such as United Utilities and National Grid, Ofgem’s December ruling which introduced price controls for companies that own electricity and gas infrastructure in Britain could reduce earnings in this division by close to 40%. At present, SSE’s regulated electric and gas networks account for around 50% of the group’s earnings. Consequently, this presents a major headwind for the company and poses the question as to whether a potential break-up between the renewable energy division and the regulated gas and electricity segment is on the cards. Depending on how this develops, the company may have to solve the trade-off between the high dividend payment and renewable investments in the future.

Notwithstanding this, SSE remains an attractive investment for those looking for exposure to the Electric Transmission/ Distribution sector; it currently offers a dividend yield of c.5%, well above its peer-group average, while its Return on Equity of 28% dwarfs that of its rivals. Moreover, the shares have a forward price to earnings ratio of 15x which once again looks more attractive than its competitors. This, together with the structural tailwind propelling growth and inflation-linked cash flows, fashions a more attractive investment opportunity.
This article was taken from issue Ten, Market Insight. To subscribe to our investment publications, please visit www.redmayne.co.uk/publications.

Please note that investments and income arising from them can fall as well as rise in value. This communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned.
 
Riding the Wave
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