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Centrica - Interim profits dip, dividend maintained

George Salmon | 31 July 2018 | A A A
Centrica - Interim profits dip, dividend maintained

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Centrica plc Ord 6,14/81p

Sell: 66.12 | Buy: 66.18 | Change 0.24 (0.36%)
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Centrica's first half adjusted operating profit of £782m is 4% lower than the prior year, as a recovery in exploration and production (E£P) was offset by weaker returns in the customer-facing divisions.

That dragged earnings per share down to 6.4p, slightly behind consensus forecasts. The shares fell 4.1% on the news.

The group has declared a 3.6p interim dividend, and envisions maintaining the full year payment at 12.0p.

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Our view

Centrica is in the midst of a turnaround. We can see the attractions of where it's trying to get to, but the journey's proving far from smooth.

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

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

The group has around 25m existing customers as well as strong, recognisable brands. If it can play to these strengths, through cross-selling additional services (such as the Hive wireless smart products) and improve efficiency, it should be capable of growth.

Early progress on the transformation was reasonable. However, things don't look quite so rosy now. Higher wholesale prices and a looming price cap mean returns in the Consumer division might well be squeezed, especially as customer outflows continue. Centrica's business-to-business division is also struggling.

There are a couple of silver linings. Higher wholesale prices are boosting returns from the remaining E&P assets, while the £200m cost cutting program is progressing nicely. As a result, cash generation is still heading in the right direction, and debt reduction is on track.

By emphasising these points, Centrica is clearly trying to steer investors away from any thoughts of a dividend cut. It's not proving 100% successful.

If Centrica pays 12p as promised, that'd give a yield of 8.1% next year. However, an average of analyst forecasts gives a yield of only 7.3%, suggesting the future of the payout is uncertain at best.

This is probably because while lower capital expenditure, the sale of its stake in nuclear power assets and those cost savings will help keep the wolf from the door, such measures can't continue forever.

For Centrica to ease worries on the dividend, investors will need to see the energy supply business stabilise. That makes Ofgem's upcoming announcement on the price cap crucial.

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First half trading details

Centrica says maintaining its dividend at 12p this year will depend on it delivering higher adjusted operating cash flow, and debt reduction.

Net debt of £2.9bn is down 2% from the equivalent stage last year, and the group remains confident of hitting its year-end target of £2.5bn-£3bn. Centrica also says it's on target to deliver year-end adjusted operating cash flows of £2.1bn-£2.3bn, despite the half year figure falling 11% to £1.1bn, as a result of the cold weather and higher wholesale commodity prices.

These headwinds pushed Consumer profits down 20% to £430m. UK profits fell 20% to £393m despite flat revenues. The impact has been partly mitigated by May's price increase, but wholesale prices have continued to move against the group since then. Consumer account holdings are down 1%, a lower rate than has been seen recently.

The Irish business also saw profits fall, but the US posted adjusted operating profits of £66m, up 14%. That was boosted by its exit from the loss-making residential solar business. Losses in Connected Home totalled £44m.

Centrica Business' adjusted operating profit fell 57% to £96m as a strong underlying performance in energy marketing and trading and a recovery in UK and US business-to-business sales was more than offset by the anticipated losses legacy gas contracts.

Higher production and prices helped E&P deliver adjusted operating profits of £256m in H1 2018, up from just £56m in H1 2017.

The group delivered £92m of cost savings in the half, and remains on track for £200m of savings over the full year.

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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 for more information.