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UTILITY WEEK | 26Th FEbrUarY - 3rd march 2016 | 19 Finance & Investment Analysis S ince former Labour party leader Ed Miliband announced a plan to impose a 20-month cap on energy prices in late September 2013, Centrica's share price has headed south. This trend accelerated with the plunge in wholesale gas prices, resulting in Centrica's market value virtually halving over the past 18 months. The market was warned by chief execu- tive Iain Conn in a December trading state- ment that 2015 had been "a difficult year", so it was expected that Centrica's figures would be poor. And they were (see table). The key message, though, was the unre- lenting focus on the £2.25 billion adjusted operating cash flow, slightly above the 2014 figure. Crucially, Centrica has adopted a "baseline 35" strategy, whereby its cash flow projections are predicated on a minimum $35 per barrel Brent oil price, a 35p per therm national balancing point gas price and a £35 per megawatt-hour UK electricity price. Assuming that prices do not fall below these benchmarks for any length of time, Centrica feels confident it can underpin its earnings. Elsewhere in the results, there were few surprises. Revenues at £28 billion were down 5 per cent on 2014; a similar decline was applicable to underlying earnings. Adjusted earnings per share were 17.2p, compared with 18.0p in 2014; a reduction in the tax charge from 30 per cent to 26 per cent, due to lower exploration and production returns, mitigated the earnings per share fall. A final dividend of 8.43p was announced, giving a full-year payment of 12p per share: the 2014 equivalent was 13.5p. With a divi- dend cover of 1.4x, investors should feel reasonably reassured about Centrica's future dividend payment capability. The market, too, welcomed the 9 per cent decline in net debt, which is now £4.7 billion – and comparatively far lower than other big six energy players. Overall, Conn was right to highlight a "resilient financial performance, with solid 2015 adjusted earnings, despite the challenge of falling wholesale oil and gas prices". Given its exploration and production dif- ficulties, returns from British Gas's residen- tial energy supply business are especially important. In 2015, operating profit from this segment was £577 million, compared with £439 million in 2014. While average gas use per customer rose last year by 5 per cent, British Gas has implemented two tariff cuts, equivalent to a saving of around 10 per cent for customers. Less satisfactory has been British Gas's business division, which delivered poor returns and faced ongoing billing problems. While there was a robust performance from its Norwegian assets, Centrica's overall exploration and production operating profit was dire, down 73 per cent. And, despite a £21 million increase from its 20 per cent stake in the eight nuclear power stations that are now majority-owned by EDF, generation returns remain poor. Inevitably, the unplanned outage at the CCGT plant at Langage had a negative impact, and overall operating losses from generation were £118 million, a similar figure to 2014. Neither figure, it has to be said, will encourage potential investors to build new gas plants, although they could probably negotiate a very favourable gas supply deal. Significant progress has, though, been made in the US energy supply markets – a priority for the new Centrica. The Direct Energy Business was the standout performer, with sharply rising operating profit, due in part to cold weather in early 2015. Direct Energy Residential also increased its returns. Particularly striking in the overall accounts was the large post-tax impairment charge of £1,846 million. Around 80 per cent of this was attributable to production assets, whose cash flow potential has been heavily reduced by falling prices. Much of the remaining impairment charge related to power stations, most notably the 20 per cent nuclear power station stake. Given all the events of the past 18 months or so Centrica has been fundamentally reviewing its strategy. New Centrica will increasingly be focusing on "customer-facing activities of energy supply, services, the con- nected home, distributed energy and power and energy marketing and trading". From this somewhat convoluted mantra, it can be deduced that exploration and pro- duction will play a far less prominent role. Generation will also be scaled back, as its confirmed exit from the wind sector dem- onstrates. Capital expenditure, which has already been sharply pruned, will be increas- ingly targeted towards the chosen priorities, including the US energy supply market. As such, Centrica's exploration and pro- duction aspirations have been cut back, with a new target of producing between 40 and 60 million barrels of oil and gas equivalent (mmboe) a year, compared with 80 mmboe for each of the past two years. Looking forward, reducing the operat- ing cost base will be pivotal: an annual cut in operating costs of £750 million by 2020, when compared with base costs in 2015, is being targeted. If this strategy is success- ful, Centrica should be able to deliver an adjusted operating cash flow comfortably in excess of £2 billion a year for the foreseeable future – assuming that the three baseline 35 prices do not trend below that level. Nigel Hawkins, director, Nigel Hawkins Associates Centrica's red lines It's been an awful year for Centrica but the company hopes its full year results mark a turning point and that it has identified a strategy for rebuilding its profits and share price. By Nigel Hawkins. GROUP FINANCIAL SUMMARY 2015 Change on 2014 Revenue £28.0bn (5%) Adjusted operating profit £1,459m (12%) Adjusted effective tax rate 26% (4ppt) Adjusted earnings £863m (4%) Adjusted basic earnings per share (EPS) 17.2p (4%) Full year dividend per share 12.0p (11%) Adjusted operating cash flow £2,253m 2% Return on average capital employed 11% 0ppt Group operating costs £3,039m 5% Group net investment £855m 3% Group net debt £4,747m (9%) Statutory operating (loss) (£857m) nm Statutory (loss) for the year attributable to shareholders (£747m) nm Net exceptional items after tax included in statutory (loss) (£1,846m) nm Basic earnings per share (14.9p) nm