In my previous post, I analysed 10 years’ worth of Centrica’s income statement and balance sheet data and it reveals some interesting truths. When energy prices rose from 2003 to 2014 (albeit a mini slump in 2008/09). Back then, management believes high energy prices were here to stay.
It led to them into long-term contracts of building their gas production and storages with the purpose of growing profits more rapidly. However, the reverse has happened, which culminate to writing off £6.2bn in asset value and the share price falling by 50%.
Given the huge write-downs (which is equivalent to 27% of the cost of assets), it looks as if their assets are fairly valued. Is this the start of a recovery where value and dividend investors can take advantage of?
Before we answer that question, there are several things we need clearing up, they’re:
-Evaluating their 2017’s interim results;
-Evaluating Centrica’s cash flow statement;
-Assessing commitments and the state of their pensions.
Update on Centrica’s New Objectives
From Centrica’s interim results, they’ve made progress in their £750m in costs savings programme over three years and by year-end savings of £650m is expected. That’s equivalent to 3% of sales, but has so far failed to boost adjusted earnings!
Using 12-month trailing earnings equation to forecast adjusted earnings for full-year 2017, we get £449m + £895m – £507m = £837m. So, that the cost-savings programme has to stop adjusted earnings from declining! Therefore, without it, Centrica’s adjusted earnings would have fallen to between £100m and £200m.
The company new objective is to be customer focus and reduce their gas production and storage division, hence the asset write downs. They have committed £1.5bn to enhance their customer accounts by 2020. So far customer accounts dropped by 4%. Their North American business has fallen by 11% from last year.
But it saw progress on net debt when it came down to £2.9bn with the target being £2.5bn-£3bn by year-end, a climbdown from £5bn.
However, this reduction in debt was down to several factors:
-Last year, Centrica issue £700m in share proceeds, that saw the share price skid 9% that day;
-Capital spending stay at roughly £1bn for two years, when the average is £2bn;
-Now, it has put up £1.3bn worth of assets up for sales.
Putting this together, Centrica has seen revenue declined by £2.4bn.
The Truth on Capital Spending of Centrica
First, let’s see how post-tax net cash flow covers dividends and interest costs.
Over the past 15 years, Centrica’s net cash flow covers dividends and interest costs over 2.2 times.
But, Centrica’s empire-building has cost them £26bn of capital expenses since 2001, whereas net cash flow manages £29.6bn in cash inflows, leaving it with a surplus of £3.6bn to fund cash interest and dividends, which isn’t enough!
Total Dividends and Interest paid comes to £12bn, so Centrica is £8.4bn short.
How doe it fund their obligations and dividend pledge?
Centrica has funded this by: –
Disposing assets worth £4.3bn;
Net proceeds of shares (minus share buybacks) of £2bn;
It has received dividends from investments and joint Ventures totalling £1bn;
Finally, net borrowings came to £3.2bn.
There is one thing that determines Centrica future capital spending, that is their commitments.
This is what Centrica’s commitments look like:
It has grown from £245m in 2005 (a bit misleading because the year after it saw commitments rose to £1,520m) to £4,708m today.
However, the reduction in capital spending for the past couple of years could mean long-term agreed upon contracts are falling behind schedule. That is displayed below when their capex/commitments ratio is approaching six years.
The last time capex/commitments ratio approach three years was back in 2011, that saw capex spending rose from £1bn to £2.3bn in2012. Either Centrica will double or triple current levels of capital spending or is this the reason why it is disposing of £1.3bn of assets to reduce future commitments?
But, digging deep into the notes, Centrica has agreed to sell part of their Canadian gas production and storage for £240m, although it requires regulatory approval.
Also, Centrica agreed to sell power stations to EP UK Investments Ltd for £318m in cash. That transaction is likely to go through.
These assets sales will release cash and help pay for their new business objectives.
Will this be enough to plug capex spending? I think it will help, but we need to assess other major factors before coming to a full conclusion.
Centrica’s operating lease and pensions
Centrica’s annual operating lease was as high as 1% of total revenue and is winding down fast. Total operating lease peaked at £975m in 2013 and is down to £381m. That means the annual operating lease fell to £91m from £154m, three years ago.
It’s part of the annual cost savings programme.
However, Centrica’s pension deficit is a concern, especially when bond yields are low. Last year, Centrica saw pension deficit increased by £900m, despite a £994m return from pension assets.
So, how will the pension deficit change in 2017?
Centrica’s interim has shown that deficit has fallen to £922m, an improvement of £200m.
Customer Accounts (Important)
The turnaround hasn’t been going according to plan as it loses over 1.3m UK customers and 0.5m North American customers, but gained 0.07m Irish customers in two years!
Will this mean lower energy prices because if that’s the case, then will margin get squeezed?
Also, future earnings and margins will be at risk because of strong competition.
Centrica’s market capitalisation is at their lowest since 2005. With a valuation at £11bn, there is value in investing for the long-term. There are some reasons why you would invest: –
-Impairments totalling £6.2bn has been written off, this means assets are close to fair value and future write downs will be at a bare minimum;
-It continues to dispose assets for cash to fund their customer service division;
-The reduction in net debt to £2.5bn to £3bn means investors hold more of the company.
-It has raised electricity prices.
Despite two years of declining business, Centrica hasn’t successfully turn around their operations, when we consider these factors: –
-Cost savings of £750m in three years is to stabilised adjusted earnings rather than improve margins;
-It has loss 1.8m paying customers from their UK and North America operations. That raises questions of stiff competition leading to the reduction in operating earnings.
-The drop in the British Pound mean rising costs acquiring gas.
In the short-term, Centrica’s share price could drop to £1.50 per share, due could recover later in 2018, if customer numbers stop falling and start to increase.
Thanks for reading, the next Centrica’s post will look into their cash flow statement, market valuation and much more.
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The opinions expressed by the writer is for entertainment and research purposes. It does not constitute professional investment advice. Data is correct on available information at the time.
Finally, the writer does not own the company’s stock, unless stated otherwise.