U.K.-Based Energy Utility SSE PLC Downgraded To 'BBB+' On Weaker Credit Metrics; Outlook Stable

  • Energy company SSE announced on Dec. 17, 2018, that it will not proceed with the plan to combine its household supply business in the U.K., SSE Energy Services, with npower Group PLC. We understand the company remains committed to looking at other options to separate SSE Energy Services.
  • Considering the challenging market conditions in the U.K. electricity and gas supply market, we believe that it is very unlikely that any debt will be transferred as part of any spinoff or any other type of transaction involving SSE's supply business, which could have offset some of the loss of cash flow for SSE and support deleveraging.
  • We now forecast S&P Global Ratings-adjusted funds from operations (FFO) to debt at about 18%-20% for financial years 2019-2021, a level we do not see as commensurate with the 'A-' rating.
  • We are therefore lowering our long-term ratings on SSE to 'BBB+' from 'A-' and the rating on the hybrid debt to 'BBB-' from 'BBB' and removing them from CreditWatch negative.
  • The stable outlook reflects our expectation that the company can maintain FFO to debt at about 18%, thanks to its regulated networks' stable contribution and an increasing contribution from renewable generation.
LONDON (S&P Global Ratings) Dec. 20, 2018--S&P Global Ratings today lowered 
its long-term issuer credit rating on U.K.-based energy utility SSE PLC to 
'BBB+' from 'A-'. The outlook is stable. 

At the same time, we lowered our issue rating on SSE's existing senior 
unsecured debt to 'BBB+' from 'A-' and our rating on the hybrid debt to 'BBB-' 
from 'BBB'. 

We removed the ratings from CreditWatch with negative implications, where we 
had placed them on Sept. 19, 2018 (see "SSE 'A-' Rating On CreditWatch 
Negative On Profit Warning And Inflexible Financial Policy," published on 
RatingsDirect).

We affirmed our short-term ratings on SSE's commercial paper at 'A-2'.


The downgrade reflects the challenging market conditions in the U.K. gas and 
electricity supply market, SSE's recent loss on energy trading operations, and 
our perception that the shareholder remuneration policy remains inflexible. As 
a result, we expect that adjusted funds from operations (FFO) to debt for 
financial years (FY) 2019-2021 (ending March 31) will be at about 18%-20%, 
below the level we view as commensurate with the previous rating. This 
anticipates S&P Global Ratings-adjusted EBITDA of £2.1 billion-£2.2 billion 
and total adjusted debt of about £9.2 billion for FY2019 (compared with about 
£2.55 billion of S&P Global Ratings-adjusted EBITDA and £9.1 billion total 
adjusted debt in FY2018).

On Dec. 17, 2018, SSE announced that it would not proceed with the plan to 
combine its household supply business in the U.K., SEE Energy Services, with 
npower Group PLC, a subsidiary of innogy. We understand that multiple factors 
influenced the decision to call off the merger, including the deterioration of 
npower's operating performance and the default tariff cap announced by the 
energy regulator Ofgem in November 2018 (for more information, see "How 
Regulatory Reset, Brexit, And Other Political Risks Weigh On U.K. Utility 
Ratings," published on Dec. 12, 2018, on RatingsDirect).  

We understand that SSE will continue to look at other options to separate the 
supply business and consequently will continue to account for it as assets 
held for sale. Considering the challenging market conditions in the U.K. 
electricity and gas supply market, we believe that it is very unlikely that 
any debt will be transferred as part of a spinoff or any other type of 
transaction involving SSE's supply business that could have offset some of the 
loss of cash flow for SSE and support deleveraging. 

At the same time, we recognize that EBITDA is likely to expand over the next 
few years as new generation capacity comes on line. Notably, the commissioning 
of Scotland's largest offshore wind farm, Beatrice, could offset the loss of 
cash flow from the supply business. Although we expect overall generation 
capacity to decline from 11.1 gigawatts (GW) in March 2018 to slightly above 
10GW in March 2022, we expect profitability to improve as SSE shifts the 
energy generation mix towards renewables and away from fossil fuels such as 
coal, which have a limited contribution. We consider that SSE's renewable 
assets benefit from a favorable subsidy regime that supports the stability of 
its generation earnings. We recognize that the company remains subject to 
operational and execution risks during the development period, but we note 
that SSE has built a solid track record. In addition, we expect that in the 
long term, capacity payments will also enhance the predictability and 
stability of revenues from wholesale generation. We note, however, that due to 
a ruling by the EU's General Court of Justice, the capacity market has entered 
a standstill period that prevents the U.K. government from making any capacity 
payments under existing agreements. We view the issue with the capacity market 
as procedural and expect the standstill to be temporary, with a solution to be 
agreed by the end of 2019. We expect the net impact on SSE to be relatively 
limited in FY2019.

We also understand that SSE has taken steps to better manage its trading 
activities, including its approach to hedging. This follows the heavy losses 
suffered by the company (expected to be around £300 million for FY2019 and 
£115 million for FY2020), which were directly related to its Energy Portfolio 
Management (EPM) activity. The objective of the new approach is to reduce 
SSE's exposure to volatility in the price of commodities and to make their 
impact more predictable. Although the results of such changes are still to be 
tested, we take a positive view of SSE's more prudent stance toward these 
activities. 

We expect SSE's credit metrics to decline over the coming two years. This is 
notably because of a decrease in EBITDA, the large capital expenditure (capex) 
program directed toward building new renewable generation capacity and 
extending the transmission network, and inflexible dividend payments. As a 
result, and despite potential asset disposals (such as minority stakes in 
renewable projects), we expect FFO to debt to be at about 18%-20% over 
2019-2020. This compares to FFO to debt of about 25% over 2017-2018. 

The stable outlook reflects our expectation that the company will be able to 
maintain FFO to debt at about 18%, thanks to its regulated networks' stable 
contribution and an increasing contribution from renewable generation. When 
analyzing our credit metrics, we consider that retail operations will be 
separated from the rest of the group.

We could lower the rating on SSE if adjusted FFO to debt falls to 
significantly less than 18% on a sustainable basis. This could occur, for 
example, if wholesale prices or wholesale generation were to materially 
decline from our current expectations, if SSE undertook debt-funded 
acquisitions or expansion, or if it earns lower returns from the regulated 
subsidiaries due to underperformance of allowances.

An upgrade could result from a sustained improvement in credit metrics, such 
that our forecast of adjusted FFO to debt improves to clearly above 20% with 
positive generation of free operating cash flows, stable operating 
performance, especially from trading operations, and clarity on the disposal 
of the supply activities. The target for an upgrade would remain 23% absent 
the separation of the supply business. 
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