Over three years ago, in January 2015, Iain Conn took the helm as the chief executive of Centrica. He came on board following a difficult 12 months for the group, which saw it post a statutory operating loss of more than £1.1 billion. Announcing the annual results in February that year, he slashed the dividend by 30 per cent and launched a wide-ranging review of the company’s strategy.
Six months later in July, Conn revealed its conclusions. The group would undergo a major pivot away from its struggling gas and power businesses and towards what he saw as the company’s future: energy supply and services. Thousands of jobs would be cut in an effort to rein in costs by £750 million a year by 2020. Investments in power would be refocused on distributed and flexible generation.
Peter Atherton, an analyst at investment firm Jefferies at the time, said the strategy would be “challenging” with “no guarantee of success”.
“But,” he added, “Centrica’s management have at least now given shareholders a plausible business plan that offers a chance that the business can survive, and possibly flourish.”
Restructuring
Last year saw the completion of the first phase of the transition. The company ended its foray into wind in January with the sale of its stake in the Lincs offshore windfarm.
In June, it disposed of its last large-scale generation assets – the Langage and South Humber gas plants – as well as agreeing the sale of its exploration and production businesses in Trinidad and Tobago and Canada.
Centrica ended the year with the merger of its European exploration and production portfolio with that of Bayerngas Norge to create a new company, Spirit Energy, in December.
Last week, the group released its preliminary financial results for 2017. Explaining progress so far, Conn told reporters: “We’ve repositioned the portfolio; we’ve reallocated resources towards the customer; we’ve delivered on our major efficiency programme of £750 million per year three years early.”
Despite a 3 per cent rise in revenue to £28 billion, adjusted operating profit was down 17 per cent at £1,252 million. Earnings before interest, tax, depreciation and amortisation (Ebitda) dropped 9 per cent to £2,142 million and statutory operating profit fell four-fifths to £486 million.
The number of household customer accounts for both home services and energy supply plunged by 1.725 million – or 7 per cent – to 24.4 million. This included the loss of 1.4 million energy supply accounts, corresponding to 750,000 customers.
Conn gave assurances that this was a not a sign of failure. It instead reflected a deliberate attempt by the company to shed around one million loss-making accounts.
Most were acquired through collective switching schemes at a breakeven margin as part of an unsuccessful attempt to later upsell home services to the new customers – a mistake that would not be repeated.
These customers had little interest in Centrica’s other offerings and just wanted a cheap deal. Many were loss-making even before overheads. Just 200,000 of the dropped accounts were actually generating any profit for the company.
“While we don’t like losing any customers,” said Conn, “clearly our focus is on selling energy to make a profit, not to make a loss.”
He said the dip in group profit resulted from the “weak” performance of its business division, particularly in North America, where it was hit by changing market conditions and an accounting error dating back several years. Adjusted operating profit fell two-thirds to £161 million.
The consumer division, by contrast, was “very resilient”, with adjusted operating profit down just 1 per cent at £890 million, despite warmer weather and the introduction of the prepayment price cap.
Adjusted operating profit for its UK operations rose 1 per cent to £819 million and earnings from energy supply increased 5 per cent to £572 million. The profit margin per customer, which since 2009 has ranged between £42 and £65, remained broadly level at £59 – or around 6 per cent.
Nevertheless, Conn said the company needs to be leaner still. He outlined plans to slash annual costs by a further £500 million a year by the end of the decade. To do this, a further 4,000 jobs will have to be cut, bringing total losses to 9,500. This will be offset somewhat by the addition of around 2,000 new roles, roughly half of which have already been created.
Conn said the decision was partly driven by the trend towards lower-cost online and digital interactions with consumers, as well as “fierce” competition in the retail sector from nearly 70 suppliers, “most of whom lose money”.
However, he also attributed some of the job losses to the looming introduction of a price cap on default energy tariffs. He refused to quantify the impact of the cap or rule out further job cuts in future.
Conn denied that he was trying to pin the blame on government. “We are not blaming anybody,” he remarked. “We’re not in a blame game here. But we’re a business. We’ve got to respond to the circumstances.”
That said, he was keen to emphasise where the jobs cuts would likely fall, noting that 80 per cent of its UK workforce is based outside of the South East, much of it in “some of the more challenged areas of the country”.
Conn confirmed the price cap would affect British Gas’s margins but said the company was aiming to reduce costs by £20 per dual fuel customer by 2020 to counteract its effect. “That way we think we can handle, as best we can, the price cap without fundamentally making the business unattractive,” he said.
British Gas is withdrawing its standard variable tariff (SVT) from the market at the end of March. The supplier moved a net total of 700,000 customers from its SVT on to fixed price deals last year and Conn said it would do the same for another 1.3 million customers in 2018. As of the end of 2017, British Gas had 4.3 million customers on SVTs.
Conn said the company was already less exposed to the price cap than many of its competitors, both big six rivals and challenger suppliers.
“Relatively, our is already £41 below the average of the other large suppliers, and actually its £100 below some of the highest prices in the market,” he said. “That means others are going to hurt first and more than us as long as we maintain that competitive position.”
Future prospects
Utilities analyst Nigel Hawkins says the company’s performance over 2018 will be heavily influenced by three key factors: the weather; the level of the price cap; and customer numbers.
If the weather is warm, the price cap is tight and British Gas continues to bleed customers, then the £819 million operating profit for the UK portion of the consumer division will be “considerably less”.
However, even if the company can hold its ground following the introduction of the price cap, Centrica will need to do more to prove the success of the new strategy. The results from the supposed growth areas are hardly worth shouting from the rooftops.
Home services accounts grew by 77,000 over the second half of 2017, the first half year increase since 2011, but were flat over the whole year at 7.47 million. Adjusted operating profit fell 4 per cent to £247 million.
Revenues from distributed energy and power increased by just 6 per cent at £171 million and the business posted an adjusted operating loss of £53 million, compared with a £26 million loss the previous year.
The connected home unit saw faster growth. Hub sales grew by 59 per cent to 373,000, bringing the cumulative total to 900,000, and subscriptions nearly tripled to 94,000. Revenues rose 27 per cent to £42 million.
But, just as with the distributed energy and power business, it remains a drain on Centrica’s resources, reporting an adjusted operating loss of £95 million due to increased investment. This compares to a £50 million loss in 2016.
Centrica has previously said it expects the businesses to break even by 2019, with combined revenues rising to £2 billion by 2022. It has plenty of work left to do to reach those targets.
Clearly, things could have been worse. At the time of publication, the group’s share price had risen 9 per cent to 144p since the announcement of the results, reflecting its decision to maintain the dividend at 12p.
But this was partly paid for by its numerous divestments over the year.
Centrica has also confirmed plans to divest its 20 per cent stake in Britain’s existing nuclear fleet as it seeks to maintain the dividend at 12p out to 2020. However, it can obviously only sell these assets once.
“The results were poor as expected,” says Hawkins. “Clearly, there are concerns about the UK core business… which faces many challenges.
“The non-core businesses don’t appear to be cutting the mustard in terms of profitability and are unlikely to do so for some time. I think they’ll be hard pressed to sustain their dividend.”
The share price is still barely half of what it was when Conn joined the company in 2015, and with the price cap fast approaching, the wolves are at the door. If Conn is to stem the decline in the company’s fortunes, he will need to show a marked improvement in its growth areas in next year’s results.