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Company Comprehensive Analysis

Centrica Plc

March – 2018

Mohammad Abdelqader
Mohamad.abdelqader@gmail.com

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 Table of Contents

Executive Summary …………………………………………………………………………………. 3

Introduction …………………………………………………………………………………………….. 4

The Company ………………………….………………………………………………………………. 4

Centrica Analysis......…………………………………………………………………………………. 5

Profitability Analysis ………………………………………………………………………. 5

DuPont Analysis ……………………………………………………………………………. 7

The liquidity Analysis …………………………………………………………………… 9

Cash Movements and Financial Gearing Analysis ……………………… 11

Investor Analysis ….…………………………………………………………………… 12

Price / Book ratio………………………………………………………………… 12

Dividends ……..……………………………………………………………………. 13

Conclusion …………………………………………………………………………………………… 15

References ……………………………………………………………………………………………. 16

Appendices ……………………………………………………………………………..………….. 19

Centrica Fair Value ………………………………………………………………..…………….. 19

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 Executive Summary

Centrica plc was reported as one of the worst performing shares in 2017
according to the FT.com41. This Report aims to investigate the reasons behind
Centrica’s poor performance and explore its probability of future prosperity. To
achieve this goal, Centrica is analysed using performance analysis, analysis of
positions and investor analysis.
The results show that Centrica suffers from low profitability per customer, in
addition to high financial leverage and cost of financing. The deterioration of
Centrica’s performance took place mainly in North-America and the UK. North-
America operations suffered from dropping in business-segment market share
that attributed to the high competition. However, in the UK, tariffs increase,
implementing the prepayment cap, the increase in inputs cost, and the warm
weather are the main causes of Centrica’s bad performance.
Regarding its future prosperity, Centrica’s performance is threatened, especially
with the expected increase in government intervention. Moreover, Investors are
losing trust in Centrica’s management, which Centrica is trying to restore by
adopting an aggressive dividend policy that cannot sustain for long.
Furthermore, the analyses show that Centrica multiplies are generally below the
market average which reflect the market expectations. There is no material
indicator that the current conditions would be changed in the near future
horizon. Therefore, the results show that Centrica is overpriced.
However, Centrica strategy should mainly focus on enhancing assets turnover,
and enhance profit margin through decreasing the production costs as a
secondary strategy, rather than working on products differentiating.

In conclusion, Centrica is suffering from a poor performance that will continue

unless the company obtained a radical change strategy.

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Introduction
Centrica, the UK giant utility provider was reported as one of the worst-
performing stocks in 2017. The share price dropped distinctly in 2017 hitting the
lowest price level during the last five years. This report aims to analyse the
performance of Centrica, positions and investor valuation to determine whether
Centrica is investment-worthy.
This report focuses on the last two years of performance. For benchmarking
purposes, RWE AG is used as a benchmark since it has almost the same
operations as Centrica.
The Company
Centrica is a fully-fledged UK-based energy company that provides electricity,
natural gas, home services and gas storage services3. It has eight main business
segments, for which EM&T, ES&S-North-America and ES&S-UK and Ireland
accounts almost for 95% of the total revenues30 as shown in figure(1).
EM&M and ES&S revenues in North-America recorded a significant increase by
41.9% and 5% respectively, which offset the revenues drop of ES&S UK and
Ireland by 7.77%.

Figure 1: Centrica Business Segments Breakdown as in 2017 [30]

14,000.0
Total Revenues (£ Million)

12,000.0
10,000.0
8,000.0
6,000.0
4,000.0
2,000.0
0.0
Energy
Energy
Energy Supply &
Distributed Exploration Central Supply &
Centrica Connected Marketing Services
Energy & & Power Services
Storage Home & Trading (ES&S) -
Power Production Generation (ES&S) - UK
EM&T North
& Ireland
America
Revenues '16 74.0 25.0 159.0 3,194.0 771.0 458.0 10,366.0 12,055.0
Revenues '17 133.0 28.0 167.0 4,532.0 671.0 426.0 10,880.0 11,186.0

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Centrica Analysis
Profitability Analysis
Centrica profitability sank dramatically in 2017 due to the poor performance of
Centrica-business segment in UK and North-America because of subdued
demand and plentiful supply6. Besides, the whole sale price cutting7, production
breakdown in Morecambe-Bay gas field30, high input cost, and warmer
temperature that led to lower energy consumption 4.

Figure 2: Revenues Growth vs. Gross Profit Margin [13]

28,200 25.0%
27,971 28,023
28,000 20.1% 20.0%
27,800
15.6% 15.0% 15.0%
27,600
£ Million

10.0%
27,400 Revenues
5.0%
27,200 27,102 Centrica - Growth Rate
3.4% 0.0%
27,000 Gross Profit Margin
-3.1% -5.0%
26,800 -4.9%
26,600 -10.0%
2015 2016 2017
Year

Almost 10% of Centrica customers switched-off due to the competitive pricing

that new entrance offered in 2017 and Centrica strategy8.
However, the company managed to increase its total revenues by 3.4% in 2017
through bundle sales. But in April 2017, the prepayment cap was implemented
which led to high competitive environment that also drawdown gross-profit
margins4.

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 Figure 3: Profitability Analysis [13] [20]
6,000.0 25.0%
5,000.0 20.0%
4,000.0
15.0%
£ Million

3,000.0
2,000.0 10.0%
1,000.0 5.0%
0.0
-1,000.0 0.0%
-2,000.0 -5.0%
2015 2016 2017
Gross Profit 4,353.0 5,449.0 4,195.0
Operating Profit -857.0 2,486.0 486.0
Net Profit -747.0 1,672.0 333.0
Gross Profit Margin 15.6% 20.1% 15.0%
Operating Profit Margin -3.1% 9.2% 1.7%
Net Profit Margin -2.7% 6.2% 1.2%
Year

Although Centrica has adapted cost efficiency program since 2015, which aim to
reduce the company costs by £750 million by 20174, this didn't help to maintain
its operating and net-profit margins. The operating-profit margin dropped by £2
billion to record 1.65% in 2017 compared to 8.8% in 2016, accompanied by a
drop from 6.17% to 1.56% in the net-profit margin as shown in figure(3)13.
This drop is affected by the low gross-profit margin and non-recurring losses;
£76 million refers to 2013 and £476 million related to impairments of E&P
Assets, beside losses for legacy gas contracts and DE&P Investments, and the
effect of current higher interest costs4.
However, the released information does not justify the drop of £2 billion in
Centrica operating income which raise a question about its financial statements
accuracy and its performance.
Even though Centrica gained 161 million from the US tax system reformulation
in 20173, this didn't help the company to maintain the net-profit margin due to
the low gross and operating-profit margin.

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DuPont Analysis
Centrica adopted a reposition strategy in 2017 that focused on maximising the
shareholder-wealth through enhancing the profitability/customer 4. This
strategy comes from the fact that Centrica has an outstanding assets turnover
as seen in Figure(4), thus maintaining the assets turnover and enhancing the
profit margins would amplify the shareholders wealth.
Therefore, Centrica worked on differentiating its products through providing
online services, smart meters, on demand platform for seasonal and unusual
offers and centralization of planning and dispatching to ensure high quality of
service4.
Profitability enhancing strategy requires optimising the fixed cost allocation, and
then move toward enhancing the profitability/customer.

However, Profitability Enhancing strategy pushed Centrica to sacrifice 1.37

million of UK Home customers in 2017 which accounts for 10% of the total UK
Home customers through increasing standard Tariff electricity price by 12.5% in
September4. But the profitability/customer dropped sharply so, this strategy
failed to accomplish its goals as shown in Figure(5).

Figure 4: Benchmarking - DuPont Analysis 2017 [16] [26]

18.00
16.00
14.00
12.00
10.00
8.00
6.00 Centrica
4.00 GWE AG
2.00
0.00
Operating
Tax Burden Interest Burden Assets Turnover Leverage Ratio
Margin
Centrica 2.34 32.64% 1.55% 1.32 7.93
GWE AG 0.74 77.11% 7.90% 0.58 15.29

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 Figure 5: DuPont Analysis for ROE[16]
12.00

10.00

8.00
Ratio

6.00

4.00

2.00

0.00
Operating
Tax Burden Interest Burden Assets Turnover Leverage Ratio
Margin
ROE - 2016 0.76 89.44% 9.02% 1.32 10.68
ROE -2017 2.34 32.64% 1.55% 1.32 7.93

Continuing in such strategy hold a bleak outlook about Centrica market position.
Especially that price is the only factor that attracts customer since the products
are undifferentiated, and buyers are independent and can switch in low cost10.

Figure 6: Investor Benchmarking [31]

14.00%
12.41%
12.00%
10.20%
10.00%

8.00%
6.50%
6.00%

4.00%
1.56%
2.00%

0.00%
ROA % WACC % ROE % CAPM

Figure(6) shows that the ROA and ROE fell dramatically in 2017 due to the drop
in the company’s earnings. Centrica ROA was 1.56% in 2017 lower that the
WACC which was 6.5% which clearly shows that the return on assets was
unsatisfied.

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The ROE reported 12.41% higher that the CAPM (10.20%) but this attributes to
the unusual tax burden ratio which was mainly supported by the tax benefit
from the US taxes reformulation. However, table(1) shows that the ROE would
be 4.03% without considering this unusual event which is significantly lower
than the CAPM.

Liquidity Analysis.
Centrica strategy during the last three years focused on maintaining its credit
rating by enhancing the liquidity position 5.

Figure 7: Liquidity Analysis [18]

1.40
1.20
1.00
0.80
Ratio

0.60
0.40
0.20
0.00
12/31/2015 12/31/2016 12/31/2017
Cash Ratio 0.14 0.26 0.39
Current Ratio 0.93 1.18 1.23
Quick Ratio 0.45 0.55 0.39
Ratio

The peer analysis shows that Centrica’s current ratio is slightly better than RWE
AG. It has been increased YoY to reach 1.23 in 2017. The quick ratio was reported
0.39 times, the spread to current ratio is attributed to the high concentration of
inventory in the current assets (68.7%).

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 Figure 8: Benchmarking - Liquidity Analysis 2017 [18] [27]
1.40
1.20
1.00
0.80
Ratio

0.60
0.40
0.20
0.00
Current Ratio Quick Ratio Cash Ratio
RWE AG 1.15 0.79 0.43
Centrica 1.23 0.39 0.39
Year

However, this concentration is worthless to notice, since the inventory is

saleable (Inventory holding period is 6 days), but this can raise the risk of stock-
out.

[12] [13]
Figure 9: Cash Conversion Cycle
90 84 82
81
80
69
70 64
61
60
50
days

Inventory Holding Period

40
Receivables Collection Period
30
20 Payables Payment Period

10 6 6 6

0
2015 2016 2017
Year

In general, Centrica working-capital management is considerable. The company

matches between cash collection and payments by optimizing the billing system
and by efficient credit collection.

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Cash Movements and Financial Gearing Analysis
Although the operating cash-flow dropped by 32.2% in 2017 due to poor
profitability, Centrica managed to increase its cash position by 40.7% to report
£2,846 million by suspending investment activities, which could affect the
company’s future value.
Centrica also managed to reduce its financial-gearing to 83.4% to maintain its
credit rating (baa1(Moody’s),BBB+(Fitch))3, by paying £752 million into debt
paybacks as figure(10 and 11) show. Appendix (A) shows the analysis of interest
coverage Ratio.

Figure 10: Cash Movement Analysis [14]

3,500
3,000
2,500
2,000
£ Million

1,500
1,000
500
0
(500)
(1,000)
(1,500)
2016 2017
Cash from Operating Activities 2,400 1,628
Cash from Investing Activities (1,011) (48)
Cash from Financing Activities (342) (752)
End of Period Cash 2,036 2,864
Year

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 Figure 11: Benchmarking - Debt to Assets [12] [22]
94.0% 93.0%

92.0%
90.5%
89.9%
90.0%

88.0% 87.0%

86.0% 85.2% Debt to Assets - Centrica

83.4% Debt to Assets - RWE AG

84.0%

82.0%

80.0%

78.0%
2015 2016 2017

Investor Analysis
1. Price/ Book ratio
Figure(12) shows that the intrinsic-value of Centrica has shrunk significantly
during the last three years because of the company’s poor performance and the
unfavourable market conditions, which are expected to continue in the
upcoming years.

Figure 12: Centrica P/B Ratio [21]

10.00 9.38
9.00
8.00
7.00
6.00
Times

5.00 4.81

4.00
2.85
3.00
2.00
1.00
0.00
2015 2016 2017

2. Dividends
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 Table 2 : Dividend Yields [21]
Ratio 2013 2014 2015 2016 2017
Dividend per share £ 0.17 0.14 0.12 0.12 0.12
Price Per Share £ 347.7 279 218.1 234.1 137.3
Divided Yields 0.05% 0.05% 0.06% 0.05% 0.09%
Data taken from Bloomberg

Table(2) shows that Centrica has fixed its dividends/share since 2015 at £0.12
aiming to reduce share prices free-fall6, but this strategy didn’t work since
the price/share slumps YoY to reach £137.3 in 2017, causing an illusory
increase in the dividends yield.

Figure 13: Price Per Share vs. Dividend Yields [21]

400 0.10%
350 0.09%
0.08%
300
Price Per Share £

0.07%

Divided Yield
250 0.06%
200 0.05%
150 0.04%
0.03%
100
0.02%
50 0.01%
0 0.00%
2013 2014 2015 2016 2017
Price Per Share £ 347.7 279 218.1 234.1 137.3
Divided Yield 0.05% 0.05% 0.06% 0.05% 0.09%

In addition, table(3) shows that Centrica separates its dividend policy from its
profitability, causing to pay 1.79 times of its cumulative income through the last
three years (1,939/1,081), resulting in dividends pay-out ratio and sustainable
growth rate to be 198% and -12% in 2017, respectively as in table(4). Which
would negatively affect its future investment plans.

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Table 3 : Dividends Coverage Ratio [13] [15]
Interest Coverage Ratio 2015 2016 2017 Total
Income to shareholders (£ Million) -884 1,662 303 1,081
Total Dividends (£ Million) 608 659 672 1,939
Dividends Coverage Ratio -1.45 2.52 0.45 NA
Data taken from Bloomberg

[16]
Table 4 : Dividends Pay-out Ratio vs. Sustainable Growth Rate
Ratio 2015 2016 2017
Dividends Pay-out Ratio NA 39% 198%
Sustainable Growth Rate NA 53% -12%
Data taken from Bloomberg

Centrica Fair Value

To determine the fair value of Centrica, the method of comparable is applied
Table(5) and figure(14) show that peer companies have better investment ratios
than Centrica except the P/B, which indicates that market expects the peers
companies to perform better than Centrica.
Table 5 : Peers Multiples [33] [34] [35] [36] [37] [38] [39] [40]
Company Name P/E (x) EV/EBIT (x) EV/Rev (x) P/BV (x)
RWE AG 11.3 7.6 0.5 1.6
MVV Energie AG 17.3 14.0 0.7 1.3
REN - Redes Energeticas Nacion 13.9 16.0 5.2 1.2
Italgas SpA 11.8 16.7 6.4 3.2
Enagas SA 11.8 15.1 7.8 2.0
Snam SpA 13.0 17.2 9.3 2.0
Fluxys Belgium SA 31.7 26.1 6.4 2.9
Peers Average 15.8 16.1 5.2 2.0
Data taken from Bloomberg

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 Figure 14: Peer Analysis [33] [34] [35] [36] [37] [38] [39] [40]
EV/EBITDA (x)
1
0.8
0.6
0.4
P/BV (x) P/E (x)
0.2
0

EV/Rev (x) EV/EBIT (x)

Centrica PLC Peers Average

Table(6) shows that the FV of Centrica share is £7.34, which is lower than the
current price range. Consequently, Centrica’s share is overpriced.

Table 6 : Centrica Fair Value [12] [13]

Item Earnings EBIT Revenues Book Value
Centrica values (£ Million) 303 463 28,023 3,428
Enterprise Value (£ Million) 4,796 7,454 145,319 6,954
Average EV (£ Million) 41,131
Av. Com. Outstanding Shares (Million) 5,600
Fair Value of Share (£) 7.34
Data taken from Bloomberg

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Conclusion
Centrica demonstrates poor performance in both North-America and the UK
region attributed to intense competition, unwise decisions, government
intervention and high weather temperatures, resulting in an alarming drop in
the profitability/customer.
Beside the low profitability, Centrica suffers from a high financial-leverage and
poor multiples making its share overpriced. However, Centrica maintains a good
liquidity and working-capital management.
To survive, Centrica should rethink its strategy and focus on assets turnover. In
addition, the current share price presents a good opportunity for Centrica to
raise capital before a further drop in the share price occurs. This could lead to
decrease debt ratios and cost of debt, and finance the requirements of its
turnover-based strategy.

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 References
1. Centrica Annual report and accounts 2016.

2. Statistica.com, Average annual Exchange Rate.

3. www.centrica.com

4. Bloomberg, Q4 2017 Earnings Call

5. Centrica preliminary results for the year ended December 2017.

6. Ft.com; Centrica investors blindsided by America woes.

7. Ft.com; Centrica profit warning triggers record one-day share price fall

8. economist.com; Switched off

9. MarketLine Industry Report; Power Generation in the United Kingdom

10. MarketLine Industry Profile; Utilities in the United Kingdom

11. MarketLine Industry Profile; Electricity Retailing in the United Kingdom

12. Bloomberg Database, (2017) Centrica, Balance Sheet, As Reported

31/12/2016 and 31/12/2017.

13. Bloomberg Database, (2017) Centrica, Income Statement, As Reported

31/12/2016 and 31/12/2017.

14. Bloomberg Database, (2017) Centrica, Cash Flow Statement, As Reported

31/12/2016 and 31/12/2017.

15. Bloomberg Database, (2017) Centrica, GAAP Highlights, 31/12/2016 and

31/12/2017.

16. Bloomberg Database, (2017) Centrica, DuPont Analysis, 31/12/2016 and

31/12/2017.

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17. Bloomberg Database, (2017) Centrica, Growth, 31/12/2016 and 31/12/2017.

18. Bloomberg Database, (2017) Centrica, Liquidity, 31/12/2016 and

31/12/2017.

20. Bloomberg Database, (2017) Centrica, Profitability, 31/12/2016 and

31/12/2017.

21. Bloomberg Database, (2017) Centrica, Stock Value, 31/12/2016 and

31/12/2017.

22. Bloomberg Database, (2017) RWE AG, Balance Sheet, As Reported

31/12/2016 and 31/12/2017.

23. Bloomberg Database, (2017) RWE AG, Income Statement, As Reported

31/12/2016 and 31/12/2017.

24. Bloomberg Database, (2017) RWE AG, Cash Flow Statement, As Reported
31/12/2016 and 31/12/2017.

25. Bloomberg Database, (2017) RWE AG, GAAP Highlights, 31/12/2016 and
31/12/2017.

26. Bloomberg Database, (2017) RWE AG, DuPont Analysis, 31/12/2016 and
31/12/2017.

27. Bloomberg Database, (2017) RWE AG, Liquidity, 31/12/2016 and

31/12/2017.

28. Bloomberg Database, (2017) RWE AG, Profitability, 31/12/2016 and

31/12/2017.

29. Bloomberg Database, (2017) RWE AG, Stock Value, 31/12/2016 and
31/12/2017.

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30. Bloomberg Database, (2017) Centrica, Segments, 31/12/2016 and
31/12/2017.

31. Bloomberg Database, (2017) Centrica, WACC, 31/12/2016 and 31/12/2017.

32. The Guardian; Centrica shares suffer biggest one-day fall as British Gas
loses 823,000 accounts.
33. Bloomberg Database, (2017) Centrica, Multiples, 31/12/2017.
34. Bloomberg Database, (2017) RWE AG, Multiples, 31/12/2017.
35. Bloomberg Database, (2017) MVV Energie AG, Multiples, 31/12/2017.
36. Bloomberg Database, (2017) REN – Redes Energeticas Nacion, Multiples,
31/12/2017.
37. Bloomberg Database, (2017) Italgas SpA, Multiples, 31/12/2017.
38. Bloomberg Database, (2017) Enagas SA, Multiples, 31/12/2017.
39. Bloomberg Database, (2017) Snam SpA, Multiples, 31/12/2017.
40. Bloomberg Database, (2017) Fluxys Belgium SA, Multiples, 31/12/2017.
41. FT.com; Charts of the Year: The boring but beautiful UK stocks you missed
in 2017.

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 Appendices

Appendix (A):

Figure 15: Interest Coverage Ratio[13] [23]

14.00
12.00
10.00
8.00
Times

6.00
4.00
2.00
0.00
-2.00
-4.00
-6.00
2015 2016 2017
Centica Plc -3.36 11.69 1.46
RWE AG 0.29 -4.53 3.70
Year

Figure (15) shows that the interest coverage ratio of Centrica dropped
dramatically in 2017 to 1.46 times (11.69 times in 2016) due to the poor
profitability and the high gearing. The further unfavourable market conditions
raise the risk of default in an extended case.

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