Interim Results 2015 and outcome of Strategic Review

FIRST HALF RESULTS

Financial summary

Unless otherwise stated, all references to operating profit or loss, taxation, cash flow, earnings and earnings per share throughout the announcement are adjusted figures, reconciled to their statutory equivalents in the Group Financial Review on pages 12 to 15.

Performance summary

• Group adjusted operating profit down 3%, with higher profit from customer-facing businesses more than offset by lower profit from upstream gas and power businesses; Group adjusted EPS up 17%, reflecting a lower tax rate due to the change in operating profit mix.
• British Gas operating profit up:
  • Higher residential energy consumption due to colder weather compared to a warm first half of 2014, falling wholesale gas costs, net lower other costs including ECO; residential energy market share broadly stable.
  • Two reductions in household gas bills totalling 10% this year, saving customers £72 per year on average.
  • Residential services impacted by challenging sales environment; new propositions to be launched in second half of 2015.
  • Business energy supply impacted by issues following the implementation of a new billing and CRM system; actions in place to resolve issues by the end of 2015.
• Direct Energy operating profit significantly up:
  • Managed extreme cold weather well in residential and business energy supply, with no repeat of additional costs incurred in 2014.
  • Increased bundling of offerings in residential energy supply and restoration of higher margin contracts sold in prior periods now benefitting business energy supply.
  • Accelerated investment for future growth in solar business, resulting in an operating loss in services.
• Centrica Energy operating profit and earnings down reflecting lower wholesale gas, oil and power prices:
  • Flat year-on-year E&P production and good nuclear operational performance.
  • On track to deliver E&P capital expenditure and cash production cost reductions.
• Good first contribution from Bord Gáis Energy; Centrica Storage operating profit broadly in line with 2014.        
• Interim dividend per share down 30%, following the decision earlier in the year to rebase the dividend.
• Good progress made in strengthening the balance sheet and financial metrics; successful hybrid bond issuance and strong first-time scrip dividend take-up; Group free cash flow positive with net debt reducing by around £300 million since the start of the year.
• Full year outlook broadly unchanged, but uncertainties include continued low wholesale commodity prices and a competitive environment for our customer-facing businesses, as well as the ongoing resolution of British Gas business energy supply billling issues;  Group adjusted basic EPS expected to be weighted towards the first half of the year.

STRATEGIC REVIEW

In light of significantly changed circumstances a fundamental strategic review was launched in February, focused on:      i) outlook and sources of growth; ii) portfolio mix and capital intensity; iii) operating capability and efficiency; and iv) Group financial framework.  The review has been a thorough and rigorous analysis of the Group’s prospects, led by Centrica’s senior management.  The headline conclusions are:

• Centrica’s strength lies in being a customer-facing business.  We are an energy and services company.  Our purpose is to “provide energy and services to satisfy the changing needs of our customers”.
• Our activities and priorities will therefore be focused on meeting the needs of our customers and the shape of the Group will reflect this.  Sources of competitive advantage include strong market shares, good brands, deep energy services capability and the ability to process a high volume of transactions at scale.
• We will aim to deliver long-term shareholder value through both returns and growth:
• Operating cash flow growth of 3-5% per annum, underpinned near term through efficiencies.
• Progressive dividend policy, in line with sustainable operating cash flow growth.  
• Return on average capital employed of 10-12%.
• Our long-term growth focus will be on energy supply, services, distributed energy and power, the connected home and energy marketing and trading.  Relative to 2015, we will commit about £1.5 billion of additional operating and capital resources to drive growth in these areas over the next five years.
• Energy supply a key contributor to Group cash flow. Growth driven through cost efficiency, improved customer service and retention across all markets, and growth in share in the Republic of Ireland and North America, to offset competitive intensity and energy efficiency.
• Services growth through efficiency and an expansion of our product offering, including propositions for landlords in the UK and protection plans and solar in North America; expect to invest an additional £250 million of operating cost into services growth over the next five years.
• Distributed energy and power a material opportunity with B2B customers, including energy efficiency, flexible generation and new technologies alongside energy management systems and optimisation; £700 million of additional operating and capital resources expected to be invested in this area over the next five years.
• Connected homes growth through capitalising internationally on our existing UK market-leading position and end-to-end capabilities; expect to invest £500 million of operating costs and capital expenditure in this area over the next five years, in capacity and capability.
• Energy marketing and trading growth through leveraging our proven optimisation and risk management capabilities to LNG and route to market services; expect to invest an additional £150 million in operating costs and capital expenditure over the next five years.
• We will reduce and limit scale in E&P and central power generation, lowering the Group’s capital intensity.  Relative to 2015, resource allocation to these areas will fall by about £1.5 billion over the next five years.
• Transition to a smaller E&P business of between 40-50mmboe per annum, focused on the North Sea and East Irish Sea, consuming £400-600 million of annual capital expenditure.
• Limit our emphasis on central thermal power, with skills migrated to distibuted energy and power.
• Exit our remaining wind joint ventures.
• Our interest in the UK’s nuclear fleet considered as a financial investment.
• Aim to release £0.5-1.0 billion of divestment proceeds by 2017 from E&P and wind.
• In addition to the shift in future resource allocation, we will target cost efficiencies of £750 million per annum by 2020 relative to a 2015 baseline, with about two-thirds of the savings expected to be delivered by the end of 2018.  This excludes the costs of smart meter installation.  Net of inflation, and before additional investment in growth areas, we expect our like-for-like 2020 operating costs to be £300 million below 2015.
• Activity driven in four areas:  customer-facing businesses; Centrica Energy; Group functions including corporate centre, and; procurement and supply chain optimisation of third party costs.
• Focus on simplification, consolidation, automation and support function transformation.
• A common operating model will be established across all customer-facing geographies to leverage international scale and pursue synergies.
• With additional allocation to growth areas, we would expect our reported operating cost base in 2020 to be at or below 2015 having offset inflation and growth.
• We expect this programme to reduce like-for-like headcount by about 6,000 roles, with about half through turnover and attrition and about half through redundancies.  With investment in growth areas, we expect the net impact on headcount to be about 4,000 roles.
• We will manage the Group within a clear financial framework:
• Compound annual growth rate (CAGR) in operating cash flow of 3-5% per annum until 2020, based on flat real oil and gas prices and normal weather.
• Operating cost growth below inflation, with the cost efficiency programme more than offsetting inflation in the near term.
• Capital expenditure limited to £1 billion per annum in the near term and no more than 70% of operating cash flow longer term, to underpin dividend and credit rating.
• Return on average capital employed of 10-12%.
• Strong investment grade credit ratings of Baa1/BBB+ or better.
• Progressive dividend policy, in line with sustainable operating cash flow growth.  

Iain Conn, Centrica Chief Executive

“The conclusion of our strategic review provides a clear direction for the business.  Centrica is an energy and services company.  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.  Serving our customers is what we are known for, what we are good at and where we already have distinctive positions and capabilities.  Alongside a major Group-wide efficiency programme, this will underpin long-term shareholder value, as we target operating cash flow growth of 3-5% per year and deliver a progressive dividend policy.  With Centrica delivering solid financial and operational performance in the first half of the year, and making good progress in strengthening its balance sheet and reducing net debt, the Group is well placed to compete materially against the emerging long-term trends in global energy markets.”