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20 | 28Th FEbrUarY - 6Th March 2014 | UTILITY WEEK Finance & Investment Analysis H aving inherited the British Gas brand for its exclusive use in the UK, Cen- trica retains its strong position in the domestic gas market, where its market share is around 42 per cent. It is so strong, in fact, that a full-blown inquiry by the Competition and Markets Authority is on the cards. Theoretically, Centrica could, in time, be forced to divest part of its UK gas business, on a similar basis that the British Airports Authority was progressively dismembered. However, this formidable domestic market share does not necessarily guarantee size- able profits, despite having raised domestic gas bills by 8.4 per cent and domestic elec- tricity bills by 10.4 per cent last November. In reality, Centrica is "under the cosh" from headline-seeking politicians, as its 2013 year-end results statement made clear. "Recently, we have seen unprecedented focus on the energy sector in the UK, with intense political and media scrutiny…" the statement laments. In particular, as its subsequent share price weakness has emphasised, Centrica's profits are vulnerable to the 20-month price pledge by Labour leader Ed Miliband. Were Labour to prevail in May 2015 and implement this pledge, Centrica's profitability – and consequently its dividend stream – would be seriously affected. Against that background, it is no surprise that Centrica is reassessing its long-term strategy. It is not alone. Another big six inte- grated energy company, the much-troubled RWE, is doing likewise, although in its case the urgency is more obvious. Having already invested significantly in North America, Centrica is well-placed to develop its business further there, espe- cially downstream. Upstream, Centrica has acquired a portfolio of oil and gas assets, which may be enhanced. Despite all the political brouhaha, Cen- trica's 2013 full-year results met market expectations. Full-year operating profit was £2.7 billion, 2 per cent lower than the 2012 outturn. But underlying earnings per share (EPS) were flat at 26.6p, while the dividend was increased by 4 per cent. In terms of profitability, there were some variable performances, the best of which was achieved by Centrica Energy, whose operating profit exceeded £1.3 billion. The other three divisions – British Gas, Direct Energy and Centrica Storage – all reported lower profit, with the storage short- fall being almost 30 per cent. Most disap- pointingly, Centrica's 2013 full-year loss from its CCGT (Combined Cycle Gas Turbine) plants was a whopping £133 million. While Centrica has sought to diversify from its existing UK base, it recognises that its core UK gas business is pivotal. Indeed, Centrica has secured a massive 20-year gas supply deal with the US-based Cheniere. The contract covers 89 billion cubic feet of liq- uefied natural gas, equivalent to supplying annually 1.8 million UK homes. Direct investment in North America has also been to the fore. The recent £478 mil- lion acquisition of Hess's Energy Marketing business should strengthen Centrica's US subsidiary, Direct Energy Business. Further- more, Centrica has participated in several exploration and production "tuck-in" deals, not only in the UK but also in Norway and North America. Looking forward, Centrica has set out its "three I" policy: innovate, integrate, and increase. In essence, the mantra is sweat the existing assets and drive aggressively for high returns. In fact, with net debt of just over £5 billion, Centrica's balance sheet can comfortably absorb some further debt. Its balance sheet is far stronger than the five other big six members. So what should we expect over the medium term? Aside from the decidedly unambitious share buyback options – which Centrica has recently chosen to the tune of £500 million – there appear to be three major options. First, there is a pipeline of opportuni- ties in the upstream oil and gas sector, where Centrica has undoubted expertise. It is expected to tidy up its existing portfolio, as well as undertaking various acquisitions. Recently, Centrica sold three packages of North Sea gas assets for £175 million. Unlike most other exploration and production play- ers, Centrica needs large amounts of gas to supply its downstream UK customers. Centrica has operations in the North Sea and there are still major opportunities there. Although around 41 billion barrels of oil have already been recovered, a further 20 billion remain. Centrica will study in detail the final report by Sir Ian Wood analysing the remain- ing oil and gas opportunities in the North Sea and how more investment, especially of marginal fields, could be incentivised. Second, UK power generation, a sector needing massive investment, is currently causing real problems for Centrica. Although it controversially dropped out of EDF's new- Gas giant feeling the heat Centrica has been lambasted by politicians for hiking energy prices, but profits are flat and it is facing some hard investment decisions. Nigel Hawkins runs through the numbers. preliminary reSUlTS, year ended december 2013 (adjUSTed) 2013 2012 change Operating profit £2,695m £2,743m (2%) Earnings £1,370m £1,378m (1%) Basic earnings per share 26.6p 26.6p 0% Full year dividend per share 17.0p 16.4p 4% Group capital and acquisition expenditure £2,565m £2,727m (6%) Lost time injury frequency rate (per 100,000 hours worked) 0.11 0.20 (45%) British Gas adjusted operating profit Residential energy supply (BGR) £571m £606m (6%) Residential services (BGS) £318m £312m 2% Business energy supply and services (BGB) £141m £175m (19%) Total British Gas £1,030m £1,093m (6%)