Utility Week

UTILITY WEEK | 1ST - 7TH DECEMBER 2017 | 23 Customers Shares plummet on profit warning by Nigel Hawkins In a Utility Week feature on Centrica pub- lished 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 ra of problems that caused its share price to fall by over 15 per cent last Thursday (23 November). Iain Conn, chief executive, admitted that "some aspects of our delivery in the second half have been disappointing", while une- quivocally 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-con- firmed" price cap is pivotal – and especially the damage it will inflict on Centrica's UK residential gas margins. There is a read- across to beleaguered Tesco, whose share price has plummeted in recent years as its operating margins have been slashed. Importantly, Centrica has reiterated its plans to scrap its standard variable tariff (SVT) although details of how it will be replaced remain sketchy (see feature, overleaf). This year's autumnal weather has also not been kind: Indian summers and Centrica are not obvious soul mates. Sustained peri- ods of very cold winter weather, especially over weekends, suit its books nicely. Investors were also disconcerted by a loss of no less than 823,000 UK energy custom- ers 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 seeking to capture disil- lusioned 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 efficien- cies 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 explora- tion and production (E&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&P returns for 2017 will necessarily reflect that lack of production. Elsewhere on the E&P front, Centrica reported progress in closing its deal to establish Spirit Energy, its joint venture with Germany's Stadtwerke München. Clo- sure of the deal is expected shortly, and it should streamline Centrica's European E&P operations. The trading statement also contained negative news on Centrica's North American operations, seen by some as an expanding counterweight to offset the downstream UK energy business. However, Centrica stated that "significant market pressures in the US" have caused its operating performance to falter. Furthermore, Centrica 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 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 pro- jected 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 provi- sion – equivalent to circa 0.8p – it, nev- ertheless, 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 compa- nies, it is in hock to publicity-seeking politi- cians who seek to exploit public discontent over energy prices. Add to that the Labour party's wide-ranging utility renationalisa- tion plans and it is clear why Centrica's share price may continue to be volatile. Over the past year, its shares have fallen by almost a third, with no immediate pros- pect 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 nicely. The need for speed There is unlikely to be any knee-jerk reac- tion from British Gas, says Elmes, and this is a good thing. "Because it's not that it doesn't have a plan. But it does need to be asking 'is the plan working, and is it working fast enough?' Because if not, something's got to change, and soon." The plan for the immediacy would appear to be the SVT-scrapping announce- ment that came earlier in the same week that these results were published, but this does not come into effect until next April, so the fruits of that labour may be a long way off. Hayden Wood, co-founder of green energy supplier Bulb, agrees that speed is of the essence: "Along with the rest of the big six, British Gas will have to take swi action to deliver a different kind of energy for cus- tomers if it wants to retain, rather than lose, them." But Elmes says it is all too easy to be crit- ical of the big six, and that Conn deserves some credit: "He has forged a clear, different path for the company to move in. The ques- tion now is does he have the scale and the speed to support the continued growth of the company – and will the smaller compa- nies beat him to it if he doesn't?" With the market becoming increasingly competitive and the threat of a price cap looming, Massara says the time for change is now: "Centrica has to look to reshape its business model, with new services and new products. The wheels of this are already in motion, but it needs to be doing it much more radically, and much faster." Centrica share price five days Centrica share price five years 170 160 150 140 130 400 300 200 100 2013 2014 2015 2016 2017 22 Nov 23 Nov 24 Nov 27 Nov

• Cover