Centrica shares: where next for the vulnerable giant?
Centrica, the owner of British Gas, has lost almost three quarters of its value since 2015. Will the company find a road to recovery?
- Centrica share price plunges under CEO Conn
- Centrica’s latest results leave little to smile about
- Why is Centrica struggling?
- How is Centrica responding?
- Centrica: what’s the outlook?
- Centrica’s 2019 full year guidance
- Centrica: down, but not out
There will be little love lost when Iain Conn, the chief executive officer (CEO) of Centrica, leaves the business next year. All CEOs aim to leave a business in a better state than they found it, but there are more questions being asked about the company’s future as he departs than when he arrived.
After taking over at the start of 2015, Conn was quick to highlight that he had taken over at a challenging time for the business and that Centrica, home to the UK’s largest energy supplier British Gas, needed to change its strategy. He said the last year had been ‘very difficult’ and that falls in oil and gas prices had exacerbated the issue, and that the board had decided to cut investment, jobs and the dividend in response.
Four-and-a-half years later, upon the release of Centrica’s interim results for the first half (H1) of 2019, investors are feeling a severe case of déjà vu. The period was ‘exceptionally challenging’, once again in part to low gas prices. It announced the purse-strings are to be tightened further and more jobs will be cut. Conn even unveiled one last dividend cut as he announced he would be leaving after the company’s 2020 annual general meeting (AGM).
Centrica’s latest results leave little to smile about
Centrica’s H1 results were hard to swallow no matter which way you looked at them. Revenue was down and the company swung to a large pre-tax loss. Operating cash flow – which underpins the dividend – plunged 80%, prompting a larger-than-expected 58% cut to the interim pay-out and a decision to scrap its scrip dividend programme. Net debt is also starting to climb again after being reduced significantly over recent years, up 17% over the past year.
Centrica results (£, million)
|2014||2015||2016||2017||2018||H1 2018||H2 2018|
|Operating profit (loss)||-1,137||-857||2,486||486||987||415||-569|
|Earnings per share (pence)||(20.2)||(14.9)||31||6||3.2||4.2||(9.6)|
|Net operating cash flow||1,217||2,197||2,396||1,840||1,934||876||177|
Why is Centrica struggling?
British Gas haemorrhages energy customers to smaller suppliers
British Gas has long been the dominate player in the UK energy supply market and while it is still the largest supplier it has lost considerable ground since late 2013. For years, UK households only had six energy companies to choose from: British Gas, SSE, EDF Energy, E.ON, nPower and Scottish Power, collectively known as the ‘Big Six’. But a flurry of new entrants have disrupted the industry since regulators opened up the market. The Big Six held almost 100% of the market at the start of 2013 but today they hold just 72%, with newer rivals having gobbled up 28%. Although many smaller suppliers have collapsed, those that have found success tend to be leaner, lower-cost businesses than their larger counterparts, able to undercut on price and provide a better service, something the Big Six have not been renowned for.
All the Big Six have succumbed to the pressure of fresh competition but some have proven far more resilient than others. ScottishPower’s share has slipped to 10% from 11% over the last five years while EDF has dipped to 11% from 13%. The others have ceded far more, with SSE’s share dropping to 13% from 19%, E.ON down to 12% from 17% and nPower’s share has fallen to just 8% from 14%.
British Gas, having held 25% of the market, has been one of the largest causalities with its share standing at 19% today. The company believes it has stemmed the flow after several years, stating that there was a ‘spike in churn’ during March and April this year and that it had gained customers in May and June.
Big Six supplier's market share is gobbled by smaller rivals
UK energy price cap
Following mounting pressure on sky-high energy bills and poor service, former UK prime minister Theresa May introduced a new energy price cap that sets the limit on how much suppliers can charge their customers. The cap is designed to move in-line with the wholesale price of energy, which is what the suppliers pay, with the idea being that if wholesale prices fall (or rise) then so should retail prices, which is what households pay.
The price cap is reviewed every six months and the latest one that has just been set by regulator Ofgem will come into force at the start of October, when the cap for the 11 million households on default or standard variable tariffs will reduce by 6%, or £75, following a fall in wholesale prices that started in February. Centrica said earlier this year that it expected to take a £300 million hit from the price cap in 2019, stating it booked £70 million of one-off costs in the first quarter (Q1) of 2019.
The company, along with its peers, has been vehemently against the price cap, stating it does not believe it is a ‘sustainable solution for the market’. The price cap, twinned with fewer customers, has hit Centrica’s energy supply business hard. Adjusted operating profit from the UK dropped 73% in the H1 of the year as it lost 178,000 customers.
Low gas prices and prolonged nuclear shutdown
Centrica generates power through interests in oil and gas and nuclear projects. Its oil and gas business was spun-off as an independent company in late 2017, when it combined its exploration and production business with that of Bayerngas Norge AS. Centrica owns 69% of the company with the rest owned by former Bayerngas Norge shareholders.
The UK natural gas NBP price has been in freefall for the past year. Prices had moved above 75p per therm in October 2018 to hit its highest level since the financial crash, but dropped to bottom-out at just over 26p at the start of July 2019, according to energy consultants ERCE. Prices have recovered somewhat since to trade closer to 30p, but that is still at levels not seen since mid-2016. Centrica said adjusted operating profit from its production business was down 48% in the H1 of the year because of lower gas prices, as well as incurring the costs of unsuccessful drilling in the Greater Warwick Area, which Spirit owns 50:50 with AIM-listed Hurricane Energy.
Centrica has also owned 20% of a fleet of UK nuclear plants since 2009, including the Hunterston B and Dungeness B nuclear power stations that generate around 20% of the UK’s electricity, with EDF Energy owning the other 80%. But both plants were shut down during 2018 after cracks were found during routine inspections and remain closed today. That saw nuclear power generation fall 19% in the H1.
How is Centrica responding?
Centrica is best known for supplying electricity and gas to homes and businesses in the UK, Ireland and North America, and producing energy through its interests in gas and nuclear projects. However, it has been placing greater focus on newer areas of the business, such as selling home energy products like smart thermostats or boilers, and providing services to businesses that, for example, help them lower their bills and become more energy efficient.
Centrica to exit energy generation by offloading stakes in Sprint and nuclear stations
Centrica has been planning to exit the power generation industry for several years but has now formally announced it will dispose of its interest in Spirit energy, following its announcement that it would sell its 20% stake in its nuclear power plants in February 2018. This forms part of its strategy to shift ‘towards the customer’. The company believes generating power is too volatile a business and stretches its ability to truly deliver for the customer in terms of supplying that energy.
Centrica intends to exit both businesses by the end of 2020, but it is unclear how easy it will be to find a buyer. Its nuclear interests have been up for sale for over a year now and the fact large amounts of its capacity are currently out of action is unlikely to entice a buyer anytime soon. Centrica has said Spirit is a ‘robust, self-financing entity in a range of price environments’ but says producing energy is ‘not strategically core for Centrica’. It also argues that producing oil and gas isn’t compatible with its new strategy that is shifting toward selling devices that help customers reduce their carbon footprint and improve energy efficiency.
Interestingly, others are doing the complete opposite, with major oil and gas providers making a big push into the supply market. Royal Dutch Shell is a prime example after the oil and gas giant bought First Utility’s retail business to mark its entry into the market with over 700,000 customers. Now renamed as Shell Energy, it is one of the largest suppliers outside of the Big Six with about 3% of the market. As the value within the energy market shifts more toward areas like low-carbon generation, renewable energy, energy storage and electric vehicle infrastructure, Shell and others, including the likes of TOTAL, are diversifying to make sure they are in the best position to capitalise on these new growth areas as appetite for its traditional business of pumping oil and gas wanes. Centrica will, however, retain exposure to gas processing after it disposes of its gas and nuclear interests.
Centrica U-turn leaves investors high and dry
Importantly, Centrica has said that the £500 million-or-so it expects to generate in asset disposals will be used to shore-up the business and its balance sheet. However, that is a stark turnaround from earlier this year when Conn, having been questioned about the sustainability of the dividend and whether a cut was on the horizon, said although there was pressure on pay-outs that investors shouldn’t ‘automatically conclude that means that there’s a dividend cut coming’.
‘If we sell these businesses that are non-core for £500 million, that will more than compensate for the amount of operating cash flow that we are losing so the company’s covenant to pay the dividend will still be strong,’ Conn said just in February. But it has since made a U-turn on that decision after it said in its interim results that any proceeds would be ‘used to fund restructuring costs and underpin balance sheet to ensure strong investment grade credit rating’, which has been downgraded this year. Standard & Poor's Global downgraded Centrica’s credit rating to BBB from BBB+ in April, adding a marked improvement over the next two to three years was unlikely.
Moody’s had downgraded the stock the month before to Baa1 from A3, citing the huge amount of restructuring that needs to be done and how this will fundamentally change the investment case. ‘The Baa1 issuer rating is constrained by Centrica's increasing focus on less asset-intensive services businesses. The large majority of Centrica's remaining long-term assets are associated with its nuclear investment, which the company has designated as non-core and intends to sell by the end of 2020, and its gas production assets, which the company contributed to a joint venture in 2018 and has indicated may ultimately be sold,’ Moody’s said after Centrica’s preliminary 2018 results.
Centrica shifts toward selling home energy devices and energy services
Under Conn’s leadership, Centrica has been gradually moving toward selling more home energy devices and providing more services to businesses. By exiting power generation, Centrica is hoping to rebuild the company’s supply arm and pursue faster-growing, higher-margin opportunities in selling smart devices (like its Hive smart thermostats), providing niche services that supply recurring revenue (such as boiler installation and maintenance) and providing services to its peers and other corporations (such as advising on how to become more energy efficient or how to balance the energy grid). Conn started pursuing this strategy from the day he took over as CEO, but so far the transition has been slow and uninspiring.
Its ‘Connected Home’ business is growing. In fact, the 200,000 new Connected Home customers it acquired in all of its markets during the H1 was more than enough to offset the decline in energy supply customers, and subscriptions growth of 54% was driven by new offerings including its remote boiler diagnostic product and its cloud storage service.
But, ultimately, the prospects haven’t been anywhere near as good as Centrica had investors believe. Connected Home is still in the red, reporting a wider adjusted operating loss of £49 million in the H1 (versus a £44 million loss the year before), and Centrica has backtracked on its prospects. The company’s original ambitions were to deliver £2 billion in revenue from selling devices and providing energy services to businesses by 2022, but now it says its Connected Home division will only breakeven in 2021 and generate just £150 million to £200 million in revenue by 2022.
One of the main reasons that Centrica is far less bullish on the prospects of its Connected Home division is because it was originally too optimistic. It is confident that its Connected Home division can continue to thrive in the UK and Ireland but has conceded defeat in other markets. It has now decided to stop selling them in North America and other European markets such as Italy because it doesn’t boast the same brand awareness it does in the UK and because there is a lack of infrastructure. Going forward, Centrica is channelling its efforts for Connected Home – which has been renamed Centrica Home Solutions – into the UK and Ireland, which has obviously drastically reduced the potential size of the market.
Conn’s strategy has been and continues to be questioned by analysts, but the CEO has refused to budge. Earlier this year he said he was ‘convinced that the strategy is the right one for this company’, adding ‘the board just spent six months kicking the tyres and has come to the same conclusion, again’.
It is easy to see why Centrica has so far failed to win-round investors. With Centrica pinning its hopes on a loss-making activity with far from convincing prospects and exiting a troubled but profitable power generation business, investors are right to ponder what will drive earnings and growth going forward.
Centrica to press reset button on energy supply business
Centrica has been aggressively becoming a leaner business under Conn’s leadership with a view of reducing costs so its core energy supply arm can compete better with the flood of newer rivals. It has already delivered £1 billion in cost efficiencies since 2015 and cut 9,000 jobs, and it is now aiming to make more over the next three years. This, coupled with the exit from energy production, will make Centrica the ‘most competitive supplier by 2022’. It said it is ‘developing plans to fundamentally rebase the business and take us towards the cost base of the projected lowest cost supplier in the market’.
By introducing more automation, reducing duplicated systems and cutting non-customer facing roles, Centrica is hoping to deliver £20 of savings per dual fuel customer in real terms, ‘taking us to around the level of the projected top quartile cost position in the UK in 2022.’ This includes an ambition to shift the business online: Centrica currently secures more than half of its energy supply customers online and is aiming to increase this to 70% over the next three years.
Green shoots: there are big opportunities, but can Centrica capitalise?
While it has had to scale-back its ambitions for Connected Home, Centrica is pursuing other avenues that, if successful, could transform the business. The company’s Distributed Energy & Power division – which is being renamed Centrica Business Solutions – is responsible for supplying businesses with services and technology to help them manage their energy use. The unit, like Connected Home, is still loss-making but growing fast, with order intake in the H1 more than double that of the year before and revenue up 43% to £120 million.
But Centrica has ambitions to make the division breakeven by 2021 (matching the timeline for Connected Home to also breakeven) and grow the division’s revenue to over £1 billion by 2022, at margins of ‘around 20%’. Supplying software that can help monitor, manage and balance energy grids at a time when more intermittent power sources, such as wind and solar, is being connected to the grid will be key to hitting its targets. Earlier this year, Centrica signed a deal with one of Japan’s largest power firms, Tepco, to supply software that manages renewable energy being supplied to industrial customers in the Kyushu region in an effort to demonstrate there are green shoots for the business even if its core operations are struggling.
Building a new business with revenue of £1 billion and margins of 20% has the potential to revolutionise Centrica and turn its fortunes around. But, having been over-optimistic with its targets before, investors are justifiably wary of the company’s ability to deliver.
Centrica targets growth through electric vehicles
Another major area where Centrica sees longer-term growth opportunities is the adoption of electric vehicles and helping manufacturers build the infrastructure needed for the technology to succeed, like charging stations. As the biggest electricity supplier in the UK and one of the biggest in North America, Centrica has a clear opportunity to benefit as more transportation runs off electricity. It is major shifts in technology and consumer behaviour like this has prompted oil majors like Shell to supply energy to end users as well as producing it, knowing the future is in generating low-carbon electricity rather than pumping for oil and gas.
This initiative has been ignited by a deal Centrica has signed with Ford. The US car giant has hired Centrica as its exclusive partner to install car-charging units in customers, homes and provide a bespoke electric vehicle tariff through British Gas and its Irish energy supply arm Bord Gais Energy. As customer’s energy needs become more complex and the grid uses more clean but unreliable renewable energy, Centrica sees itself operating as a vital middleman that helps ‘control all energy management requirements of the home’, whether that be through changing your heating using an app on your phone or having the ability to charge your car at home.
Centrica: what’s the outlook?
Centrica’s strategy has failed to win over investors. Shares have dropped by over 25% since releasing its interim results at the end of July. It said it is expecting the H2 to be better than the first as it steps-up efforts to cut costs, its nuclear power plants come back online and the benefits of a larger order book in North America start to filter through. It has also said the momentum it expects to build in the H2 will continue into 2020.
Centrica’s 2019 full year guidance
Below is a list of targets that Centrica has set itself for the full year and beyond.
- Adjusted operating cash flow: Centrica is aiming to deliver the lower-end of its £1.8 billion to £2.0 billion target range. That will be lower than the £2.25 billion delivered in 2018.
- Cost efficiency savings: Centrica aims to deliver £1 billion of annualised cash efficiencies between 2019 and 2022, which has been raised from a previous target of £750 million. It is aiming to deliver £250 million worth of savings in 2019. It expects to deliver most of these savings sooner rather than later, with 85% to be locked in by 2021.
- Restructuring costs and benefits: Centrica is accelerating its restructuring plans and has said it intends to spend around £1.25 billion on restructuring between 2019 and 2022, which will deliver annualised savings of £1 billion. It has already spent £486 million on restructuring between 2016 to 2018, with £170 million booked last year.
- Job cuts: Centrica is aiming to cut between 1,500 and 2,000 jobs, mostly non-customer facing roles, in 2019 on a like-for-like basis. Centrica ended 2018 with 30,520 members of directly-employed staff, down from 33,138 at the end of 2017.
- Asset sales: Centrica is aiming to book £500 million in 2019 by divesting from ‘non-core’ assets, which includes the £231 million sale of its Clockwork home business in April.
- Capital investment: Centrica’s total capital investment in 2019 should be around £900 million, below its original £1 billion target. It has said capital investment will fall significantly once it has sold-off its interests in Spirit Energy and its nuclear fleet to ‘around £500 million’ per year. Centrica is aiming to deliver a return on average capital employed of ‘at least’ 10% to 12%.
- Net debt: Centrica is aiming for net debt to stand between £3.0 billion and £3.5 billion by the end of 2019. Net debt stood at £3.37 billion at the end of June, up from £2.88 billion a year earlier.
- Dividend: With the dividend rebased, Centrica has said it intends to pay-out a total of 5p per share in dividends in 2019. That will be 58% less than the 12p paid in 2018. ‘Beyond this, our policy will be to deliver a progressive dividend over time, linked to earnings and operating cash flow growth, and with a targeted range of cover from earnings of 1.5-2.0 times over the medium term,’ Centrica said.
Centrica: down, but not out
It is a critical time for Centrica and investors are taking stock. The company is abandoning its volatile but profitable energy generation business. Its energy supply arm remains bloated and must improve its price proposition and customer service so it can compete effectively against smaller rivals. The dividend has been cut and there isn’t a quick-fix, not one that Conn has managed to find anyway.
If that isn’t enough, investors are equally concerned about where future growth will come from. It is pinning most of its hopes on building-out its newly named Centrica Home Solutions and Centrica Business Solutions, but these have so far underwhelmed investors. It has had to significantly scale-back its ambitions for its home energy devices and its ability to make money out of supplying software and services to businesses is yet to be proven. The fact both businesses are still loss-making fails to install any confidence that it can make enough progress in these areas to offset the decline of its core business. The investment case for Centrica is now based on the long-term and whether you believe it can find more success in a new digital world shifting to decentralised, renewable-power than it did as a traditional energy supplier and producer.
But, with Centrica yet to prove it has a real future, the company looks vulnerable. It desperately needs to stem the loss of energy supply customers (which it believes it has done), otherwise the deterioration will continue. That, combined with the fact it has lost three-quarters of its value since the start of 2015, could make it an appealing takeover target. Considering oil majors and other energy companies are gradually pushing into the supply market, it is easy to see why Centrica – still the largest energy supplier in the UK and one of the biggest in North America – could be seen as a potential entry point.
Although Conn, as captain, has set the course for Centrica going forward, he is about to jump ship. While the board has supported Conn’s controversial strategy over the last five years there will be fears – or hopes – that a new CEO can steer Centrica in a different direction when they takeover next year. Either way, there will be little sympathy for Conn when he steps down, especially considering he was awarded a total pay packet of £2.4 million last year compared to £1.7 million in 2018 despite the company’s performance.
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