LONDON (S&P Global Ratings) April 7, 2020--We see SSE as relatively resilient to the effects of COVID-19 given the essential service it provides and the regulated or long-term contracted nature of its activities. In line with government guidance on tackling COVID-19, SSE is implementing a contingency plan to manage any disruption, deliver on its core responsibilities, and carry out essential operations while protecting employees and supporting customers.
Due to the pandemic, we currently expect a reduction in electricity demand (mainly industrial and commercial), which could undermine the company's merchant generation and business supply activities. However, SSE fully hedged its power production for 2020 and mostly hedged for 2021. Additionally, SSE's business supply operations, which are subject to a potential increase in bad debt if there's a spike in customer defaults, are only a small contributor to the group's EBITDA (about 3% in the financial year ending 2019). More importantly, SSE's renewable generation is protected by long-term fixed tariffs, which somewhat reduces downside risk, while its networks operations are protected by the U.K. regulatory framework that allows for the full recovery of operating, capital, and financing costs, alongside strong ring-fencing license conditions.
SSE's business resilience is also enhanced by the January 2020 divestment of the Energy Services business (U.K. residential customers) to the U.K. supplier OVO for an enterprise value of £500 million: £400 million of cash and £100 million of loan notes. SSE used the net cash proceeds from the transaction to reduce net debt. We previously stated that the transaction would have a marginal positive effect on SSE's overall credit quality. In particular, we believe it will enhance SSE's business risk profile because the company's focus will be on its core regulated networks and renewables business.
That said, SSE's 2019 results were below expectations and financial headroom is low (funds from operations to debt was 15.2% compared to our target of 18.0% for the current rating). We currently see a risk that the ratio for the financial year ending March 2020 will also remain below our target, partly because of a delay in asset divestments that could lead to higher debt. Additionally, a lower contribution from the network operations due to lower-than-expected Distribution Use of System electricity volumes and a greater number of network faults could also have a negative impact on the metrics. Our base case for a recovery of ratios in 2020 and 2021 assumes an increase in renewable generation volume. We note the announced year-on-year increase of around 25% for SSE Renewables, reflecting the commissioning of the Beatrice offshore windfarm in July 2019.
The company has not decided to curb its dividend distribution at this stage but it has stated that it will be reviewing its operational expenditure plans, as well as its capital expenditure plans for projects that have not yet reached financial close.
Our current base case is for a normalization of industrial activity over the next few months and a recovery in ratios in 2021. We recognize that SSE's renewable operation could be negatively affected if the U.K. government declares force majeure, which could halt offshore wind contracts on the back of the current pandemic, leading to a delay in the development of new projects. We also note that SSE is facing increased reset risk, as the 2021-2026 regulatory period approaches and the next price control is considered.
We will be able to assess the extent of RIIO-2's impact on SSE's energy transmission and distribution operations once the regulator provides the draft determination, which is currently scheduled for July this year. In addition, SSE has announced that it will publish its end-of-year report in mid-June. That said, we will continue to monitor the overall effect from the coronavirus outbreak on the results for FY2020 and FY2021.
This report does not constitute a rating action.
| Primary Credit Analyst: | Matan Benjamin, London (44) 20-7176-0106; matan.benjamin@spglobal.com |
| Secondary Contacts: | Beatrice de Taisne, CFA, London (44) 20-7176-3938; beatrice.de.taisne@spglobal.com |
| Pierre Georges, Paris (33) 1-4420-6735; pierre.georges@spglobal.com |
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