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Centrica - On track, despite warmer weather hitting profits

George Salmon | 1 August 2017 | A A A
Centrica - On track, despite warmer weather hitting profits

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Centrica plc Ord 6,14/81p

Sell: 45.74 | Buy: 45.81 | Change -0.11 (-0.24%)
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Reported operating profit is down 86% to £252m, primarily due to exceptional items including £367m impairments to Canadian Exploration & Production and UK gas storage assets, plus a £223m impact from the re-measurement of energy contracts. Adjusted operating profit, which excludes these exceptionals, is down 4% to £816m. The shares rose 2.6% on the news.

The interim dividend is set to be 3.6p per share, equal to 30% of the 2016 full year dividend.

Our view

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 (E&P) assets. Between 2007 and 2014 the group invested billions, leaving it very exposed when the cycle turned. The net result was a 30% dividend cut, and a share placing to shore up the balance sheet.

Going forward, Centrica is shifting its focus away from the potentially volatile world of E&P. Costs are being slashed and capital investment is set be significantly lower. The focus is instead on its downstream businesses in the US and the UK, namely Direct Energy and British Gas.

The group has the best part of 30 million existing customers as well as strong, recognisable brands. If it can play to these strengths, through cross-selling additional services (such as the Hive connected hubs) and improve efficiency, it should be capable of growth.

Progress has been reasonable so far and it is good to see the group remains confident of meeting its targets, despite the headwinds of a warmer winter and more challenging conditions in the energy markets.

Centrica's debts were still too onerous for a dividend increase last year. However, with the group confident of delivering adjusted operating cash flow of more than £2bn this year, deleveraging shouldn't be a problem. Analysts are currently pencilling in steady dividend increases from here on, with the prospective yield currently standing at 6.1%.

While this is encouraging, we still feel Centrica will need to deliver an assured execution of its plans to keep investors onside. The dilutive impact of 2016's share placing still lingers in the memory, while the looming threat of increased regulation has added an unwanted complication. The Conservatives promised to cap prices after their election victory, a move which Centrica has understandably expressed its opposition to. Nothing has surfaced as yet, but the issue is a political hot potato, so could well resurface in the coming months, or years.

Half year results

The biggest contributor to the fall in operating profits was the UK retail business, where profits fell 23% to £489m. The group says warmer than normal temperatures reduced both gas and electricity consumption, while the implementation of a prepayment tariff cap and the loss of 377,000 customers also had an impact.

In the US adjusted operating profits, including the Business and Home divisions, rose 81% to £172m. This partly reflects cost efficiency measures, as well as reduced losses from the solar business.

The group continues to move towards a more consumer focus, and has spent over £500m on acquisitions and incremental capital expenditure and revenue investment since the start of 2016. New offers including British Gas Rewards and Hive 'Welcome Home' were launched.

Elsewhere, Centrica's Energy Marketing & Trading division put in a strong performance, boosted by the Neas acquisition. Adjusted operating profits were £105m, compared to a £14m loss last year. Exploration and production capital expenditure was down 24% to £220m, with the group expecting to spend around £500m in FY 2017. E&P adjusted operating profit was £99m.

Centrica says it remains on track to achieve the 2017 targets set out in February's full year results. It has delivered half of 2017's planned £250m in cost efficiencies, taking total savings since 2015 to around £525m. With net debt falling 22% year-on-year to £2.9bn, the group remains on track to reach the £2.5-£3.0bn level targeted by the end of 2017.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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 disclosure for more information.