Interactive Investor

Centrica's British Gas in profits surge

30th July 2015 14:45

Lee Wild from interactive investor

A plunge in profits at Centrica's energy business over the past six months was only partially offset by a surge at both the UK and US residential supply operations. Thankfully, the new chief executive has a plan. A strategic review begun shortly after he joined the company in January is complete, and the former BP man has decided the customer-facing business is where the money's at.

Spending on its capital intensive gas exploration & production (E&P) and power generation businesses will be cut by £1.5 billion over the next five years. Up to £1 billion of E&P assets and wind farms will also be sold by 2017. Chief executive Iain Conn reckons Centrica can also find £750 million of annual cost savings by 2020, most of which can be in place in less than three years. This means 6,000 jobs will go - half through redundancies - although growth elsewhere in the business gives a net cut of 4,000 staff.

Instead, Centrica will exploit its competitive advantage afforded by "strong market shares, good brands, deep energy services capability and the ability to process a high volume of transactions at scale". This will drive cash flow growth of 3-5% a year and deliver return on capital employed (ROCE) of 10-12%. Annual capex will now be limited to £1 billion in the near term and no more than 70% of operating cash flow longer term. That should underpin the dividend and credit rating.

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"Our purpose is to provide energy and services to satisfy the changing needs of our customers, and as such we will focus our growth ambitions on our customer-facing activities," said Conn.

And the numbers reveal much about the shift in focus. Due to colder weather, British Gas grew adjusted operating profit by 44% to £656 million in the half-year ended 30 June, and the North American residential business made £192 million, up 368%. However, low prices meant profit at the gas division plunged by 90% to just £48 million, leaving the energy division down 78% at £116 million. It's why group profit fell 3% to £1 billion, although a lower tax rate flattered earnings per share (EPS).

At least provisional findings from the Competition and Markets Authority's (CMA) investigation into the UK energy supply market are a relief for Centrica. "These put to bed any really 'black sky' scenario, in the sense of a major 'forced' industry restructuring," reckons Investec Securities. However, the broker does admit risk remains around the potential re-regulation of tariffs.

A day before these results, Investec upgraded Centrica shares from 'hold' to 'buy' and raised its price target from 250p to 300p. Even greater efficiency gains would bump that up further.

That seems reasonable, but massive profits at British Gas will surely cause another political and media storm. Some analysts also think the highly competitive UK market will see a large chunk of any efficiency savings competed away before they hit the bottom lines at the British Gas residential, services and business divisions.

Barclays, which has just started coverage of Centrica with an equal-weight rating and 270p target, likes the company's attractive free cash flow and 4.5% dividend yield despite a 30% cut in the interim payout to 3.57p. But it doesn't like "material downside risk to consensus at current forward wholesale energy prices".

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.