Earnings Call: H1 2020

Jul 24, 2020

Good morning everyone. Thank you for joining us for Centrica's 2020 interim results presentation. I hope you're all keeping safe and well during this very odd time and while I hope to be able to see you all again in person in the near future given the current situation regarding Covid-nineteen, we're hosting today's event virtually. I'm joined here today by our new CFO Jonathan Ford, who's been enrolled for six weeks now. Jonathan has a proven track record of driving growth and efficiency and has deep knowledge of in home servicing as well as experience of working in regulated industries and I'm delighted to have Jonathan on board. Today's presentation will last around thirty minutes and there will then be an opportunity for a live Q and A. We'll also be joined by our Chairman, Scott Weaway. Before I move on to the announcement this morning that we've entered into an agreement to sell direct energy in North America, let me first summarize the first half. Whilst we were significantly impacted by the COVID-nineteen pandemic during the first half, our performance was resilient overall. Our focus has been on protecting our colleagues and our customers and as a result the business through the crisis. Dedication and commitment of our colleagues was reflected in resilient customer service levels across the business. Although adjusted operating profit was down by GBP 56,000,000 compared to last year, adjusted earnings per share of GBP 2.5 were broadly flat, albeit compared to particularly weak first half in 2019. Jonathan will go into this in more detail, showing the significant impacts of COVID on earnings, principally in our B2B activities and the mitigating actions we implemented. In addition, we took a number of actions to protect cash flow with reduced capital and restructuring expenditure and the cancellation of the 2019 final dividend. As a result, cash flows remained robust and net debt fell by GBP 400,000,000 to GBP 2,800,000,000.0 over the first half of the year. This includes a number of working capital benefits, which we expect to unwind later in the year. Jonathan will cover the numbers in more detail shortly. Clearly, significant uncertainties remain as we head into the second half of the year and therefore we're not yet in a position to provide full year guidance and we've not declared an interim dividend for 2020. But the prompt actions we've taken should position us relatively well. Let me now briefly cover what we've done to help colleagues, customers and communities through the COVID-nineteen crisis. For colleagues, we've been working hard to follow government advice to keep everyone safe whilst continuing to run our business and meet our primary aim, which is to serve our customers. Our IT capability has been supporting flexible working and home working for several years now. This meant we could rapidly shift to 15,000 colleagues working from home, including customer service agents who have historically been purely office based. The resilience of our systems has been extraordinary to date and this has opened our eyes to the potential to work more flexibly in the future. We also made adjustments to provide more flexible working options for parents and carers and our focus on supporting the mental health and well-being of colleagues has been more important now than ever. For customers as well as supplying the basic needs of heat and light, we provided additional help for those most vulnerable. Over 80,000 British Gas customers received extra assistance in the first half including advanced credit for prepayment customers, whilst in North America 90,000 customers were provided with bill assistance. We are committed to supporting those customers who need us most, thus not enabling customers to run up unsustainable levels of debt. Many colleagues have also gone the extra mile to support our communities at this time as well. Through our partnership with the Trussell Trust, our UK service engineers have delivered over 4,000,000 meals directly to those who need them most. We also increased our support levels for some charities including Cadres UK and Segess in Alberta. I'd just like to reiterate how thankful I am for the response of my colleagues to help our customers and communities in what's been an unprecedented set of circumstances. And the focus and positive energy the organization was able to release during the crisis gives me confidence that we have the people and the capability we need to deliver a successful turnaround of the company. Moving now on to the proposed sale of Direct Energy, which we announced this morning. We've been working hard over the past couple of years to address underlying challenges, which have caused us some issues in our North American business. The efforts of our team on both sides of The Atlantic to drive improvement have been impressive and today Direct Energy is a better business with a great team and I'm very proud of them. So it should be no surprise that during my time in Centrica we've had a number of approaches for this business. As with all of these things, the timing has to be right, the value has to be right and the buyer has to be right. In May, we entered into a period of exclusive negotiations with NRG Energy after agreeing a compelling financial offer. We believe NRG will be an owner who will invest behind Direct Energy and take a great business and make it even better. The headline price of $3,625,000,000 represents an attractive multiple of nearly eight times twenty nineteen EBITDA and is significantly higher than our book value. The proceeds will be used to reduce net debt and allow a material contribution to Centrica's UK defined benefit pension schemes which will of course be subject to negotiations with the trustees. This will significantly strengthen our balance sheet, giving us the foundation to build a better business with more predictable, sustainable and enduring profits and cash flows. The transaction remains conditional on approval from Centrica shareholders and other U. S. Regulatory and antitrust approvals. With the disposal proceeds being used to strengthen the balance sheet, the transaction is expected to have a dilutive effect on adjusted EPS. Direct Energy contributed around a quarter of the group's profit in 2019 and the reduction in operating profit will only be partially offset by lower net interest costs from the associated reduction in net debt. However, I and my fellow board members believe this is the right action for the group and for our shareholders. We've been clear, the restructuring of the group is our number one priority and this is an important step in that journey. The remaining group is expected to have a more stable financial profile with an increased proportion of revenues from contracted services, but the sale of North America business will remove a source of historical earnings volatility. So what does this mean for Centrica moving forward? As well as rationalizing the portfolio, we've accelerated our focus on simplifying and modernizing the company. The significant restructuring activities we announced last month are now well underway and will allow us to put the customer at the heart of everything we do. It will also allow us to reduce our overhead costs, which will allow us to be more competitive. The direct energy divestment will, when completed, simplify the group while strengthening our balance sheet and cash flows. We plan to restart the Spirit Energy disposal process once commodity and financial markets have settled, having paused earlier than the year. However, while we still own this business, we will actively manage it. And the steps we've taken with our partner and the management team at Spirit mean we expect to be, at worst, free cash flow neutral in both 2020 and 2021, even in the current low commodity price environment. Turning now to our 20% interest in The UK's nuclear power fleet. We have, along with our partner, paused the divestment process due to the ongoing operational issues. And as such, currently expect to hold an interest in Nuclear at the 2020. We'll also consider further divestments of other smaller assets or businesses if they help to simplify and derisk the group and we can realize good value for shareholders. Let me now hand over to Jonathan to cover the numbers and I'll be back in about ten minutes. Thanks Chris and good morning everyone. Before I start I'd like to say that I'm really excited to have joined Centrica. It's a company I know well as a competitor from previous roles and one I know has a lot of potential so alongside Chris and the wider management team I'm absolutely determined to make sure we realise this potential Moving straight into the first financial results as you can see from the bottom of the slide adjusted operating profit was down by 14% to £343,000,000 I'll come on to the drivers of this shortly but broadly our consumer businesses have proved resilient as you might expect from recurring revenue businesses with continued high retention rates through the COVID-nineteen pandemic and operating profit up 37 to £328,000,000 Our B2B businesses were broadly flat overall with our energy supply businesses being negatively impacted from lower demand and higher bad debt provisions offset by higher profit from our energy marketing and trading businesses, which took advantage of the volatile commodity environment. As expected, our Upstream activities were significantly impacted by the lower commodity prices with operating profit down 87% to £19,000,000 Low commodity prices were the main driver of us recognising £785,000,000 of exceptional impairment in our E and P and nuclear assets as you can see from the table on the right with our average assumed forward price assumptions for gas, oil and power falling by between 1030% since the start of the year. We also booked £251,000,000 of exceptional costs relating to last month's restructuring announcement. This will impact cash flows in the second half of the year. We now expect 2020 to be the last year of major restructuring. Moving now to cover the operating profit bridge. 2019 included a one off cost of £70,000,000 relating to a charge in Ofgem's methodology for calculating the wholesale cost allowance in the price cap in the first quarter of last year. The net impact of COVID-nineteen was I'll cover this off in more detail on the next slide. The impact of low commodity prices in the upstream business and a small negative foreign exchange movement reduced profits by a further $2.00 £7,000,000 Warmer weather in the 2020 compared to 2019 had a £60,000,000 impact across both The UK and North America. The underlying Upstream results excluding the lower commodity prices benefited by £70,000,000 from lower depreciation and tight cost control. And underlying consumer performance was encouraging with operating profit £126,000,000 higher than last year as higher underlying margins in North American business, good trading performance from EM and T in volatile commodity markets and cost efficiencies particularly in The UK services and home solutions all helped the result. Let me go into a bit more detail on the Covid-nineteen impacts. We highlighted in our April trading update the impacts we expected to see and these have broadly played out as expected. We saw slightly higher underlying residential energy demand. However, this was more than offset by the impacts of significantly lower B2B energy demand, including electricity demand being down 14% in The UK and 6% down in North America. This resulted in us having to sell back hedges with prices typically around 40% lower on average than our hedged position and increased system balancing costs in The UK as National Grid dealt with the extreme change in consumption revenues in our services business were also impacted as we prioritised essential work only As a result boiler installs were down 40% compared to last year. The other main impact is on our consumer bad debt. Cash collection trends have been broadly in line with prior years. Our customer receivables are generally short term in nature and paid down within around sixty days. So the recovery of our first half receivables will arise across July and August. Therefore, the risk is more weighted towards the second half, especially given the planned withdrawal of government support for jobs. We have however increased our bad debt provisioning rates to reflect the current economic uncertainty and risk. This has resulted in a cost of £60,000,000 although this much remains a judgment at this stage. To help give you some context our bad debt charge in the first half at the group level was around 1.5% revenue compared to 0.9% in 2019 and in 2009 at the height of the financial crisis our bad debt charge was 1.6% of revenues on an annualized basis so the first half charge is in line with that and just to give you a feel for the sensitivity on this every 0.5 increase in the bad debt charge as a proportion of revenue is worth around £50,000,000 on an annual basis In total these factors negatively impacted adjusted operating profit by £219,000,000 with the biggest impacts in April and May. However, we started to see improvements in June as lockdowns were relaxed with energy demand partially recovering and service colleagues able to start carrying out non essential work again and this trend has continued into July. Boiler installs are now running at about two thirds of where we were this time last year and we now have around seven fifty employees on furlough all of them expected to be back in September. In response we were able to mitigate the impact of Covid-nineteen by £164,000,000 through a number of actions including reductions in discretionary costs, the use of The UK job retention scheme and delay of some eco work and our decision not to pay cash bonuses to management relating to 2019. The trends we've seen in June and July indicate the COVID-nineteen impact should be less significant in the second half than in the first. However, it's worth remembering that some actions we were able to take in the first half of the year will not be available to us in the second half. And clearly we have the increased bad debt risk I referred to. So at this stage we are not providing any full year guidance. Turning now to cash flow. You can see on the left a reduction in EBITDA which mainly reflects the impact of lower commodity prices on E and P. Working capital is the big year on year change with a large swing resulting in an inflow in the first half. As revenues fell in our B2B supply businesses, the working capital requirements also reduced. This protects our cash flow position to some extent from sudden reductions in demand, albeit the reverse applies if demand increases as we hope it will do in the second half. The inflow also includes about £250,000,000 relating to timing on a number of items which we expect to reverse in the second half. The largest of these relates to a one month deferral of our Danish VAT bill. CapEx mainly related to IT spend and upstream investment and was pulled back to preserve cash. Restructuring costs were lower although these will increase in the second half as the exceptional costs flow through divestments in the first half mainly relate to the sale of the King's Lynn CCGT power station and the divestment last year related to the sale of our Clockwork business. This resulted in free cash flow for the half of £750,000,000 compared to £430,000,000 last year. There were no dividends paid to Centrica shareholders or our minority partners in Spirit Energy and there was no repeat of the one off GBP75 million additional pension contribution made in 2019. As a result, net debt inflow was £593,000,000 and when taking into account non cash movements, net debt ended the first half at £2,800,000,000 We're pleased with the cash flow in the first half and I think it helps demonstrate the flexibility that exists in our cash flow model. However, we do expect the level of net debt to rise over the second half due to the reversal of the working capital timing and higher restructuring costs. We are in a strong liquidity position. At the June we had £1,300,000,000 of available cash and £2,900,000,000 of undrawn committed facilities through our revolving credit facilities with 21 banks that run through to 2025. And we continue to target strong investment grade credit ratings which helps our ability to purchase the volume of commodity required on attractive terms. We have a legacy of long dated and relatively expensive debt which isn't ideal where it meant sense we will look to address this over time by retiring gross debt if we can do so in a value accretive way On pensions the IAS 19 deficit increased in the first half of the year to £522,000,000 reflecting a 50 basis point reduction in the discount rate over the past six months the technical provision deficit is larger as it's based on a more conservative discount rate Remember it's the technical provision deficit which determines the level of cash contributions into the fund. As part of the 2018 triennial review we agreed a technical deficit of £1,400,000,000 and annual contributions of £175,000,000 out to 2025. On a roll forward basis using the same methodology from 2018 this technical deficit would be £2,400,000,000 today and as a reminder the next triannual valuation is due as at the 03/31/2021 The disposal of Direct Energy announced this morning is a great opportunity for us to significantly strengthen our balance sheet by materially reducing our net debt and reducing our pension deficit and will result in much improved leverage ratios. Thanks, and now I'll hand back to Chris. Thanks, Jonathan. As I've mentioned, Centrica is a turnaround. It will be challenging and it will take time. But the great news is that we have the people and all the necessary levers to deliver. We're going to bring more focus to the organization with the sale of direct energy being an important first step, which means we'll do fewer things better, and we'll focus on our strengths. And rather than focusing on cost cutting, we're going to ensure that we're thinking commercially, making the right value decisions. Don't get me wrong, we're taking large amounts of overhead out of the business with our restructuring and we'll make sure that when we take costs out, they don't return. But there has to be more to us than cost cutting. A case in point is our restructuring. We're doing this to free up our colleagues to serve the customer, to get rid of all the complexity, the bureaucracy, the self made problems, get them out the way to give colleagues the space to operate freely. We have great people, but we get in their way. This will increase our agility, our ability to move quickly, and it will help us improve our execution and it should make it a more enjoyable place to work, because over the past few years colleague engagement has been declining. The more engaged we are, the happier we are and a happier colleague will provide even better service to our customers and that will improve our business. I'm committed to improving engagement across the group. And each and every one of our colleagues will be focused on the customer. I am and everyone else will be as well. As you all know, Centrica has some very strong customer facing market positions and capabilities. In total, we serve over 9,000,000 households in The UK with one or more of services, gas or electricity. We're the largest energy supplier to residential customers in The UK and the second largest supplier to small businesses. We also provide home services to 4,000,000 households, which makes us by some distance the largest player in the country. UK services is now our largest business in profit terms and with levels of customer retention consistently around 80% over the past fifteen years, this business provides a predictable and attractive cash flow stream. There are always areas for improvement, but this is a very stable business. Hyve's integration into British Gas is intended to allow us to benefit from its 1,000,000 active customers without further material cash drain. We retain a top two position in Ireland, where we have leading capabilities internationally in business solutions and in energy marketing and trading. As I indicated though, we've historically tried to do too much, and as a result, we haven't been as focused as we could have been on capitalizing on these advantaged positions. Whilst our planned divestments will in part help to resolve this, even within our retained businesses, we've been involved in activities that are unlikely to add value for a number of years. Those activities such as selling home insurance in The UK has stopped. So although we'll continue to remain active in a financially disciplined way in areas of opportunity aligned to our core positions and capabilities such as electric vehicle integration, heat pumps, the potential for hydrogen to become part of the energy mix and home energy management, our focus as a group is now in those activities where we have scale and the ability to win. Hopefully you'll have picked up that I'm really excited by the opportunities we have to deliver a turnaround. We've got a solid platform with which we can build. And in order to fulfill our potential, I'm committed to do whatever is required to deliver for our colleagues and for our customers. Broadly, this fits into four buckets. Number one, delayering the company to free up our colleagues number two, increasing the proportion of colleagues who serve the customer number three, give the customer a better experience by having each customer served by only one business unit and number four, modernize our working practices to increase flexibility both for colleagues and for customers. The first priority to simplify the group to allow our colleagues to shine. We are too complex, too bureaucratic and too top heavy as an organization and this has made it difficult for us to respond as quickly as we need to, to the changing needs of our customers with too much energy being expended on doing business with ourselves. This was the key driver behind the group restructure we announced last month, which is expected to accelerate targeted cost savings and lead to a reduction of around 5,000 roles across the group. The restructuring is well underway and is expected to be substantially completed by the end of this year. Secondly, we can operate with far fewer layers, which will give us a higher proportion of colleagues in customer facing roles. Thirdly, we will also have fewer customer facing business units, all of which will report directly to me. And importantly, it will result in each individual customer being served by only one business unit, which will undoubtedly improve the customer experience and should also improve customer retention. The new business unit structure and leadership teams are now in place, which has already resulted in us reducing around half the roles from the top three management layers in the company. And number four, we have to modernise to be successful. And I know from past experience a growing company will be a more fulfilling place to work, more energising, more fun than one in decline. We're aiming for a more flexible way of working to support our colleagues to find the right balance between their work and their personal lives, but also to be available when our customers want us. A consultation to simplify terms and conditions for our colleagues in The UK is underway, which I recognise won't be a straightforward discussion, but we need to simplify in many areas and quickly. By doing all of this, we will substantially reduce our overhead spend, including our decision to stop our material third party consultancy spend. We'll accelerate the delivery of our £2,000,000,000 cost efficiency target, albeit in a different way and at a lower cost. By getting this right, we'll be a more agile company with empowered colleagues and lower cost per customer in both energy supply and services. And this is the basis upon which all of our businesses can compete more effectively. So given the backdrop and what's just been covered, let me briefly summarize what this all means and what we believe the outcome will be. We are an energy services and solutions company, and we're already helping customers to transition to a lower carbon future. Our focus will be in the markets and the activities where we have scale and leading positions, specifically The UK and Ireland. We'll be an easy place to work, an easy place to navigate, an easy company with which to do business. We will be simpler. We'll empower our colleagues and ensure each and every person in the company is focused on the customer, not just our engineers and customer service agents but everybody. Our divestments will reduce volatility of earnings and cash flow and where we continue to own Spirit Energy and Nuclear, we will of course maintain our focus on these businesses and ensure that they do not become a drain on the group's cash flows. However, whatever the portfolio, we will also maintain our net debt at a level that is consistent with strong investment grade credit ratings. Centrica remains capable of delivering stable and significant free cash flow with limited CapEx requirements once Spirit Energy has been divested. We will obviously look to continue to maintain financial discipline to put us in a strong position to mitigate all the uncertainties that surround the current COVID-nineteen crisis. Our first half was very strong in this regard, but we are not yet out of the woods. Centric is a turnaround story, it will be challenging and it will take time, but the great news is that we have all the levers necessary to deliver for our stakeholders and a team determined to deliver it. Ladies and gentlemen, I'd like to thank you for your time and we look forward to the Q and A session shortly.