The plumbing of the next era of power use
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Five years on, we still hold SSE and expect to do so for some time to come, too. In the past few years, as AI has developed at an exponential clip, it has become increasingly clear that we’re going to need even more electricity by the end of the decade than anyone had predicted when we entered the 2020s.
SSE has never been a glamorous business. It's a UK utility, the sort of company that quietly keeps the lights on rather than grabbing the headlines. But that's the point. In a world obsessed with the next shiny thing, there's a lot to be said for owning the plumbing of the energy system – especially when that plumbing is being rebuilt from the ground up.
A three-legged stool makes for less wobbling
SSE has three distinct parts operating across different areas of the power supply chain that complement each other and can help balance out its overall performance.
Its solid backbone is its networks division. These are the pylons, cables and substations that carry power around the country. Because it's a natural monopoly – once SSE owns the wires in a region, nobody else builds a competing set alongside them – returns are set by the regulator, Ofgem, on the value of the assets SSE owns and maintains (the ‘regulated asset base’). This was made more dynamic in 2013, however, when the UK introduced a new model called ‘Revenue = Incentives + Innovation + Output’ (RIIO for short).
This structure encourages companies like SSE to innovate and find better ways of doing things rather than simply increasing capital expenditure, as any cost savings they can implement are shared 50/50 with their customers. We think this makes the company more entrepreneurial than your average monopoly utility.
The growth engine is its renewables arm. This accounts for roughly 50% of all the energy it generates. SSE builds and runs both onshore and offshore windfarms, making up about 70% of its renewable capacity. And, as you would expect for a Scottish-headquartered company, hydro makes up most of the other 30%.
SSE’s big-ticket site is Dogger Bank – the largest offshore wind farm in the world, its 3.6GW of power is still being phased in. SSE has a 40% stake alongside two other owners. Crucially, a big chunk of these earnings are linked to inflation, so when prices rise, so does the income. In the inflationary storm of 2022, that mattered enormously. And in the unpredictable world we’re still living in, this protection is very helpful indeed.
The last leg of the stool is its flexible gas generation plants. We think of this as the business’s shock absorber. Renewables are the future, but the future doesn’t always blow and sometimes water levels drop too far for generators to safely rely on them. Storage batteries are rapidly improving and over the coming years will no doubt become the power sinks that we need to smooth out volatile renewable generation. Yet in the meantime, SSE's flexible gas plants can step in on still, dark days.
Getting paid to build the future
The UK simply cannot hit its clean-energy ambitions without spending big sums on new wind farms, transmission lines and grid upgrades. SSE's answer was its Net Zero Acceleration Programme Plus, a roughly £20.5 billion investment plan expected to grow its regulated network assets by around 15% a year and more than double its renewable capacity between 2023 and 2027. The energy shock of 2022 only added fuel to that fire, turning ‘energy security’ from a slogan into a national priority.
For shareholders, that translates into a company that expected its core profits (EBITDA, or roughly the cash the business throws off) to climb from £1.3bn in 2020 towards £5.3bn by the end of the decade. A growing, inflation-linked, partly-monopoly business. That's our kind of trade.
Of course, building things is hard. And the future, by definition, hasn’t been built yet. That creates risk. Big wind projects can run late and over budget, dragging on returns – a live risk across the whole industry. And as we said, SSE has an interest in the biggest one going.
Interest costs are another important factor for SSE. As you can imagine, it uses a good chunk of borrowing to finance its very long-term projects. It has a relatively modest level of leverage at the moment – its outstanding net debt is 3.8x its EBITDA, however, it would likely need to add debt to make significant new projects, so if today’s high interest rates persist it could force it to shelve some projects as unviable. And high rates also crimp the value of steady income expected over many years to come. They're seen as ‘bond proxies’ – equities that can look like bonds – so when safer bonds offer more yield, some investors drift away. There's also a lag before the regulator lets SSE recover higher financing costs, which can squeeze profits in the meantime.
Finally, politics happens. Utilities are inherently political. Too many people rely on them for it to be any other way. A less friendly regulator, or political interference in networks or renewables, could dent returns.
Five years on
We're not ones for balloons and confetti, but as our range quietly passes its fifth birthday, SSE feels like a fair emblem of what we set out to do: own real businesses, doing genuinely useful things, bought at sensible prices. The energy transition is a decades-long project, not a five-year sprint. Happily, so is good investing.
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