In a Utility Week feature on Centrica published just a few weeks ago, we concluded that its late November trading statement was “unlikely to be overly bullish”. Bullish it certainly was not, as Centrica highlighted a raft of problems that caused its share price to fall by over 15 per cent last Thursday (23 November).
Iain Conn, group chief executive, admitted that “…some aspects of our delivery in the second half have been disappointing”, whilst unequivocally reaffirming Centrica’s long-term strategy.
Inevitably, concerns about the likelihood of another dividend cut were to the fore – a major determinant of the share price plunge. For investors, the bear case is now becoming increasingly powerful as Centrica seems to be attracting problems.
Politically, the issue of the “to-be-confirmed” price cap is pivotal – and especially the damage that it will inflict on Centrica’s UK residential gas margins; there is a read-across to the beleaguered Tesco, whose share price has plummeted in recent years as its operating margins have been slashed.
Importantly, Centrica has re-iterated its plans to scrap its controversial standard variable tariff (SVT) although details of how it will be replaced remain somewhat sketchy.
“Centrica continues to emphasise its progress in delivering efficiencies within its core business”
This year’s autumnal weather has also not been kind to Centrica: Indian summers and Centrica are not obvious soul-mates. Sustained periods of very cold winter weather, especially over weekends, suit its book nicely.
Investors were also disconcerted by a loss of no less than 823,000 UK energy customers since June 2017 – many will be permanent defectors. Moreover, the recent double-digit electricity price hike has hardly been an encouragement for existing customers to stay loyal. And, of course, there are many smaller competitors who seek to capture disillusioned Centrica energy customers – they are forever sharpening their pencils to offer highly competitive terms.
On the cost side, Centrica continues to emphasise its progress in delivering efficiencies within its core business – an initiative that will become increasingly important if residential gas margins continue to erode. In its trading statement, Centrica also updated the market on its Morecambe Bay E and P operations.
For decades, this key gas-producing field – the cash cow of yore – has been pivotal to Centrica: in the late 1990s, it was allocated to Centrica to underpin its balance sheet when it and BG went their separate ways.
The lengthy outage of Morecambe Bay ended in late October 2017 so that Centrica’s E and P returns for 2017 will necessarily reflect that lack of production.
Elsewhere on the E and P front, Centrica has reported progress in closing its deal to establish Spirit Energy, its joint venture (JV) with Germany’s Stadtwerke München. Closure of the deal is expected shortly – the JV should streamline Centrica’s European E and P operations.
The trading statement also contained some negative news on Centrica’s North American operations, seen by some as an expanding counter-weight to offset the downstream UK energy business.
However, Centrica stated that “significant market pressures in the US” have caused its operating performance to falter.
“Undoubtedly, Centrica does not lack for challenges, especially within its core UK energy supply operations and in the US”
Furthermore, Centrica has confirmed that a £76 million provision pre-tax – equivalent to £46 million post-tax – is being made to cover historic unbilled revenues: there is, though, no cash impact.
With many well-known UK companies coming a cropper in the US, investors will be nervous that last week’s unwelcome news is not just a one-off.
Despite the setbacks, Centrica was able to forecast a minimum £2 billion operating cash flow for 2017, along with a net debt range of between £2.5 billion and £3 billion at the December year-end
Centrica has also indicated a higher tax rate for 2018 compared with the forecast 26 per cent for 2017. The damage to Centrica’s share price derives principally from the cut in projected Earnings per Share (EPS).
For the full-year, EPS is forecast to be circa 12.5p. Although this figure does include the £76 million (pre-tax) one-off US provision – equivalent to circa 0.8p – it, nevertheless, represents a sharp reduction in previous projections. And, in its quest to avoid another dividend cut, Centrica has flagged that there may be a temporary period of very low dividend cover.
Undoubtedly, Centrica does not lack for challenges, especially within its core UK energy supply operations and in the US. And, unlike many other FTSE-100 companies, it is in hock to publicity-seeking politicians who seek to exploit public discontent over energy prices. Add to that the Labour Party’s wide-ranging utility re-nationalisation plans and it is clear why Centrica’s share price may continue to be volatile.
Over the last year, its shares have fallen by almost a third, with no immediate prospect of a re-rating. If 2017 has been a bit of a shocker for Centrica, its shareholders will hope that the tide turns in 2018.
A winter as cold – and as long – as that of 1962/63 would suit Centrica just nicely.