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Centrica - earnings to come in ahead of expectations

Nicholas Hyett, Equity Analyst | 14 January 2021 | A A A
Centrica - earnings to come in ahead of expectations

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Centrica plc Ord 6,14/81p

Sell: 82.50 | Buy: 82.60 | Change 0.62 (0.76%)
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Centrica expects full year adjusted earnings per share to come in ahead of market expectations of 4.8p. This follows what management described as a "resilient" second half.

UK business energy demand fell 15%, which represents an improvement on the 30% fall in the second quarter. Residential boiler installations also recovered, but are 15% lower than last year. At the end of 2020 Centrica had 6.9m UK energy supply customers and 3.6m UK services customers, both broadly flat since the half year. The current lockdown increases potential strain on services and bad debts, so management remains "cautious".

The group's restructuring plans are on track. £2.7bn from the sale of Direct Energy will be put towards the group's pension deficit and reducing debt. Full year net debt is expected to be 10% lower than last year at£2.8bn, before sale proceeds are included.

The shares rose 3.1% following the announcement.

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Our view

Centrica's uphill battle in the Home and Business divisions, while also trying to exit oil & gas and nuclear operations, has been rumbling on for a while. The challenges have only been made worse by the global coronavirus crisis and oil price crash last year.

The UK's lockdown and shift to working from home has reduced Business energy demand. And while there's been an uplift in residential demand, it's nowhere near enough to plug the gap. With both homes and businesses in immediate financial hardship - Centrica is braced for an increase in bad debts and deferred payments.

Centrica's sale of US based Direct Energy was warmly welcomed by the market. The price offered is a significant premium to the business's book value and a big step in the group's restructuring and reorganisation plans to become a "simpler, leaner business". The proceeds will allow the group to substantially improve its balance sheet, which will give management more options going forward.

The deal also takes the pressure off the drawn out sale of the group's E&P and nuclear businesses.

Retail energy supply through British Gas is now Centrica's bread and butter. It's less capital intensive, so should be more cash generative, but that's a theory the group has struggled to turn into reality. An energy price cap in the UK has also served to cap profits. And the rise of price comparison websites and smaller challengers means Centrica's found its margins squeezed and customers harder to hold on to.

The Business division, home to energy trading and business energy supply, is somewhat of a mixed picture. Returns in the trading business saved the day in the first half, but tend to be turbulent and therefore less reliable. Meanwhile business energy supply, in normal times, suffers similar challenges to the retail division.

There are signs energy demand is starting to recover, and we're pleased to see Centrica's enhanced expectations for earnings. Recent restructuring efforts are important steps in the right direction but there's still a long way to go. Until Centrica's situation becomes clearer, we think it will struggle to deliver the 'steady Eddy' performance you might expect from a utility.

Centrica key facts

  • Price/Earnings ratio: 11.1
  • 10 year average Price/Earnings ratio: 11.8
  • Prospective yield: 4.0%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Half Year Results (underlying results used, 24/07/20)

Lower demand for energy from businesses meant first half revenues fell 9% to £12.5bn, with underlying operating profits falling 14% to £343m. Taking into account exceptional items including restructuring costs and impairment charges to the E&P and Nuclear divisions - Centrica reported an operating loss of £135m, an improvement on last year's loss of £446m.

The group announced plans to sell its US energy supply business Direct Energy to NRG Energy for £2.85bn. The proceeds will be used to pay down debt and contribute to the group's £522m pension deficit. Pending approval from shareholders the transaction is expected to complete in Q4 2020.

As lockdowns ease Centrica is seeing energy demand starting to recover and without a second wave, expect this to continue. However, the group's outlook remains cautious, particularly in regard to customer bad debts, and as a result is unable to provide full year guidance.

Centrica Consumer operating profits rose 37% to £328m, largely reflecting cost savings across different divisions. In UK Home supply (home to British Gas), warmer weather and a lower number of customers accounts offset increase in energy demand as the UK worked from home. UK Home Services was disrupted by lockdown, boiler installations dropped by 40%, but a higher number of customers and use of government support helped the division remain profitable. Both Irish and North American businesses were impacted by coronavirus but only North America was able to offset the impact with cost savings. Home Solutions reduced its operating loss despite lower sales thanks to higher margin products.

Centrica Business made a £4m operating loss in the first half, compared to a profit of £9m last year, as bumper profits in the Energy Trading business offset losses in all business energy divisions. Lockdowns significantly reduced business demand which, together with increased bad debt provisions, led to the UK, North America and Centrica Business solutions all recording losses for the period - totalling £120m.

Upstream operating profit fell by 87% to £19m reflecting lower commodity prices and production. Despite this, Spirit Energy is expected to be at least cash flow neutral for 2020 and 2021. The sale of Spirit Energy and the nuclear business remains on hold.

Despite lower profits free cash generated over the first half was £750m, £320m higher than last year. That reflects a better working capital position (the difference between a company's readily available assets and debts due to be paid within a year) as more customers paid bills and the delay of a Danish tax bill - which is expected to reverse next half.

Net debt was 18% lower at £2.8bn. As at the end of June, Centrica had £1.3bn of available cash and £2.9bn of undrawn credit facilities.

In June Centrica announced a significant restructure, which is mostly expected to take place in the second half of this year. The result will be fewer business units and reduction of about 5,000 members of staff.

Thanks to the restructure, Centrica now expects to achieve its cost savings target of £2bn in annualised savings between 2015 - 2022, by next year.

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This article is original HL content, published by HL. 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.