SSE, the energy company formerly called Scottish & Southern Energy, published their annual results yesterday (for the year to March 31st). The first page of the “preliminary announcement” looked positive. It talked about Adjusted Earnings per Share up 4.1%, Adjusted Profit before Tax up 9.6% and the Full Year Dividend increased by 3.0%, among other things.
But this writer was immediately suspicious because there was no mention of revenue trends in these “headline” figures – something of importance and usually included. Revenue was in fact up by 8% but did not seem to meet analysts forecasts for a rise of 14%. Was that why it was not mentioned?
The Adjusted Earnings were ahead of forecasts, but it’s worth examining the “Adjustments” made. Adjusted Profit was given as £1,551m but the “Reported Profit” according to the normal accounting statements was only £573m. What accounts for the difference? After all a billion pounds is not trivial.
The “Adjustments” are £212m of Movement on Derivatives, £747m of Exceptional Items and a couple of other minor items. The paragraphs that describe the Exceptionals are well worth reading. I repeat some of it here:
“The pre-tax exceptional charges totalling £747.2m have come as a result of two main factors:
– the announcement, on 26 March 2014, of a ‘value programme’ of disposals of a number of non-core assets and businesses and the identification of further operational efficiencies; and
– a further significant review of the operational plant in SSE’s Wholesale segment, with a specific focus on thermal power generation plant and gas storage facilities.
The value programme is designed to ensure SSE is well-positioned for future challenges arising from the energy ‘trilemma’. As part of it, SSE announced its decision to scale back its commitment in relation to offshore wind projects and has also conducted a review of its onshore wind development projects. Non-core businesses identified for disposal include SSE’s portfolio of PFI street lighting contracts, a Telecoms data centre and the gas connections activity within Other Networks. As a consequence, SSE has recognised provisions for certain exceptional closure and exit costs associated with the programme. The announcement also referred to a programme of voluntary early release for which 600 employees have successfully applied and which will have the effect of reducing headcount across all business areas. In total, therefore, SSE has recognised exceptional asset and investment impairment costs and other charges associated with the announcement of £272.6m.
In addition to this, SSE has conducted a further significant review of its operational plant with a specific focus on thermal power generation plant and gas storage facilities. These value of these plants, which include the coal-fired power generation plants at Fiddler’s Ferry and Ferrybridge, are considered to be at specific risk due to low forecast operating margins, increasing uncertainty over coal-fired generation viability, changes arising from market reform including the creation of a Capacity Market in 2018 and the Supplemental Balancing Reserve and the ongoing economic issues associated with gas storage. Total exceptional charges of £428.2m have been recognised in respect of these asset and investment impairments, which also included £36.2m in respect of Retail-related system and software development. In addition, a provision for the settlement of a contractual dispute, of £46.4m, was also recognised as an exceptional charge in the year. “
Are these really exceptional items? In the dynamic modern world, there will no doubt be a constant need to change facilities to keep up with Government and market demands. But as they are “non cash” items, it may be best just to look at the cash flow statement. That shows cash generated from operations as £2,408 million but then they spent £1,835m on purchased tangible and intangible assets. So the leaves only £573m free cash, but oddly enough this is exactly the same as the conventional “Reported Profit” given above.
Investors might consider that the more realistic real figure for sustainable profits, because there were similar massive “Exceptionals” in the two prior years also.
Perhaps investors are buying the shares for the reliable dividend stream (current yield about 5.5%) and commitment to at least increase it in line with inflation. But they should bear in mind that the forecast p/e is not the 13.5 reported by many financial web sites, but might be more like 35 based on real cash profits.