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Centrica - Cuts continue as earnings decline

George Salmon | 28 July 2016 | A A A
Centrica - Cuts continue as earnings decline

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Centrica plc Ord 6,14/81p

Sell: 65.06 | Buy: 65.14 | Change -2.80 (-4.13%)
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Centrica have this morning released their interim results for the period to 30 June 2016. The shares moved up by 1.5% in early trading.

Analysts had been predicting a decline in revenue and earnings, and Centrica have duly reported a 13% decline in revenue and a 17% decline in adjusted earnings per share. Weaker commodity prices and warmer weather had a detrimental impact, with adjusted operating profit in the North American Home division declining by 34%, and profits in the exploration and production (E and P) division declining by 17%.

Due to a competitive environment and a significant roll-off of long-term contracts in the first quarter, the number of energy supply accounts in the UK fell by 3% (399,000 accounts). In Ireland and North America, energy supply customer numbers rose by 20,000 and 7,000 respectively.

Capital expenditure is down, in line with the group's upstream exploration and production (E and P) cuts, while cost efficiencies of £141m have been delivered, as part of the £750m p.a. cuts targeted by 2020.

The group generated net cash inflow of over £450 million in the first half of the year, before taking into account the net impact of £700 million raised through an equity placing and the £149 million acquisition of ENER-G Cogen, which completed in May. In total, net cash inflow was £1.3bn in the first half and as a result, net debt fell from £4.7bn to £3.8bn.

The 2016 proposed interim dividend per share of 3.6p is broadly in line with last year and consistent with the group's practice of paying 30% of the prior year's full year dividend as an interim dividend.

Looking forward, adjusted operating cash flow is expected to be in excess of £2 billion in 2016, with capex below £1bn. Headcount is set to fall by 3,000 this year.

Our View

Centrica's cost and efficiency savings are progressing well enough and capital expenditure (capex) is being reduced. This is helping to support cash flows, dividends and net debt reduction.

The group has stated that even if current commodity prices persist it should still be able to grow its operating cash flows, while capex in the upstream business can be reduced further if necessary. This should help underpin confidence in the dividend.

Centrica's downstream operations have always been highly cash generative. The problem is that, historically, most of this cash has been pumped into upstream exploration and production assets. Centrica invested £9bn in its upstream gas and power operations between 2007 and 2014. This left the group very exposed to falling oil and gas prices, and led to a 30% dividend cut.

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 nearly 30 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 near term market conditions look set to remain challenging, but the prospective yield of over 5% is a clear attraction in the current environment, especially with analysts expecting it to be covered by earnings and cash flows over the coming years.

The placing of 350m shares announced in May has dented confidence in the group's ability to deliver its plans organically and Centrica will need to show assured execution of its plans from here onwards, to keep investors onside.

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.