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Centrica - 'good' progress in challenging markets

Charlie Huggins | 10 December 2015 | A A A
Centrica - 'good' progress in challenging markets

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Centrica plc Ord 6,14/81p

Sell: 51.40 | Buy: 51.46 | Change -0.04 (-0.08%)
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Centrica has made 'good operational and strategic progress' in the third quarter, against a challenging backdrop of weak commodity prices and power generation margins. Cost and efficiency savings are progressing well and capital expenditure is being reduced; meaning the group is on track to deliver at least £2 billion of adjusted operating cash flow in 2015. The group's 2015 full year earnings outlook is in line with expectations. The shares rose by over 2% in early morning trading.

Operational highlights:

  • The number of UK residential energy accounts on supply is largely unchanged since the half year. Margins in H2 will be materially lower than H1 following a second 5% reduction in residential gas tariffs.
  • In North America, Direct Energy is performing well and remains on track to deliver material operating profit growth in 2015.
  • E&P oil and gas production is now expected to be above 75 million barrels of oil equivalent, higher than previous guidance, reflecting continued good well performance.

Iain Conn, Chief Executive, commented:

"I am pleased with our progress since we announced our strategy in July. 2015 has been a difficult year, and against challenging external factors Centrica is establishing a solid base from which to deliver for our customers and shareholders."

Our view:

Centrica is making good early progress with its turnaround plan, despite challenging market conditions. Analysts expect the group to generate around £1bn of free cash flow (cash available after tax, interest and capital expenditures) this year; equating to a free cash flow yield in the order of 9.5%. If Centrica can continue to execute on its new strategy, debt should come down rapidly and the dividend should be able to grow modestly . A prospective yield of 5.7% (variable and not guaranteed) suggests the share price is already discounting a lot of bad news.

Since 2007, Centrica has invested £9bn in its upstream gas and power operations. This has left the group very exposed to falling oil and gas prices. The downstream business has also been under pressure, due to falling energy demand, competition from smaller energy providers and intense regulatory/media scrutiny.

The turnaround plan is designed to improve returns on capital employed and cash flow; and make the group less susceptible to volatile commodity prices. Investment in the upstream business will be significantly cut back, non-core assets will be sold, costs will be slashed, and Centrica will re-focus on its downstream customer-facing operations.

Centrica has almost 28 million customer relationships in the UK and North America and a strong, well-recognised brand. If the group can leverage these strengths, through cross-selling additional services, while improving efficiency, it should be capable of growing in the long run. In the short run market conditions look set to remain challenging.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.