Scottish & Southern takes the high road

Utilities companies have traditionally carried large amounts of debt, leveraging their reliable long-term income streams in order to bring benefits to their shareholders. However, in the current financial climate, lots of debt is a worry for investors and, despite Scottish & Southern Energy's defensive credentials, its share price has slipped (in common with other large utility stocks) due to .

The group, which is the second largest gas and electricity supplier in the UK, surprised the market when it announced an institutional placing of 42m new shares at the end of last year. Equivalent to 4.8 per cent of existing share capital, the placing raised £479m and was reputedly taken up by all but two of its top-20 investors. But sometimes you can't win, and the move prompted some City analysts to question Scottish & Southern's ability to access the debt markets.

But their concerns look misplaced, especially as Scottish & Southern has secured a further £700m of funding by issuing an over-subscribed corporate bond with a 5.75 per cent coupon since the placing. Encouragingly, the bond was rated A by ratings agencies Standard & Poor's and Fitch. Scottish & Southern also extended a £500m banking facility relating to an acquisition in December by one year to June 2010. Additionally, a further £308m in cash has been realised from the planned disposal of its 50 per cent stake in the Greater Gabbard offshore wind farm.

Scottish & Southern says it will use these proceeds to strengthen its balance sheet, and help fund an aggressive capital spending plan of up to £6.7bn over the five years to 2013. This compares with capital spending of just £2.6bn in the previous five years. The money raised will also enable management to pursue small and medium-sized acquisitions in the £10m-£50m range - particularly of renewable energy firms. Management has already earmarked £300m to acquire two wind farms with planning consent in Scotland and Ireland. The Scottish project will have a final capacity of up to 200 megawatts and construction is due to begin later this year.

In the first half of 2008-09, Scottish & Southern reported that generation performance was hampered by delays to installing flue gas de-sulhpurisation equipment at its Fiddler's Ferry and Ferrybridge power stations, at a cost of £100m. Unplanned outages at Medway power stations, and lower-than -expected hydro-electric output cost £75m, and this led to a 77 per cent reduction in operating profit for the generation and supply division to £107m. However, operating profits rose 26 per cent to £259m in the networks division, and by 21 per cent to £35m in the energy-related services division, which includes metering, boiler servicing and gas storage.

The group has steadily grown its number of domestic customer, from 5.5m in 2004 to just over 9m today. It has maintained a competitive advantage by passing on price cuts quickly. For example, in its February trading statement, it announced that gas bills will fall by 4 per cent on average, and electricity bills by 9 per cent, effective from 31 March.

Management also expects to deliver a "modest rise" in adjusted pre-tax profits for the year just about to end, and took the step of forecasting a full-year dividend payout of not less than 66p. It also promises at least 4 per cent real growth in dividends for 2009-10. This should re-assure investors who are nervous that the big capital-spending programme might squeeze dividend growth. In addition, analysts reckon that, as Scottish & Southern completes its various projects, dividends should rise briskly.

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And against a backdrop of increasingly for energy companies, Scottish & Southern's efforts in the renewables arena are encouraging. Since its acquisition of Airtricity in January 2008, it has progressively expanded in this arena, and aims to double its renewable generation capacity to 4,000 megawatts over the next five years. Last month, Airtricity formed the Forewind consortium with three other power giants with the intention of winning exclusive rights to develop offshore wind farms in the third round of so-called Zone Development Agreements to be issued in the UK.