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Edited Transcript of CNA.L earnings conference call or presentation 24-Jul-20 7:00am GMT

Half Year 2020 Centrica PLC Pre-Recorded Results Presentation

Slough, Berkshire Jul 24, 2020 (Thomson StreetEvents) -- Edited Transcript of Centrica PLC earnings conference call or presentation Friday, July 24, 2020 at 7:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Chris O’Shea

Centrica plc - Group Chief Executive & Director

* Johnathan Richard Ford

Centrica plc - Group CFO & Director

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Presentation

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Chris O’Shea, Centrica plc - Group Chief Executive & Director [1]

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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-19, we're hosting today's event virtually.

I'm joined here today by our new CFO, Johnathan Ford, who's been in role for 6 weeks now. Johnathan 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 Johnathan on board.

Today's presentation will last around 30 minutes. There will then be an opportunity for a live Q&A that will also be joined by our Chairman, Scott Wheway.

Before I move on to the announcement this morning, 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-19 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 million compared to last year, adjusted earnings per share of 2.5p were broadly flat, albeit compared to a particularly weak first half in 2019. Johnathan 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 million to GBP 2.8 billion over the first half of the year. This includes a number of working capital benefits, which we expect to unwind later in the year. Johnathan 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-19 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 homeworking 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 U.K. service engineers have delivered over 4 million meals directly to those who need the most. We also increased our support levels for some charities, including Carers U.K. and [Seges] 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. But 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 billion represents an attractive multiple of nearly 8x 2019 EBITDA and is significantly higher than our book value. The proceeds will be used to reduce net debt and allow material contribution to Centrica's U.K.-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's 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 1/4 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 #1 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 it earlier in 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 of Spirit when 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 U.K.'s Nuclear power fleet. We have, along with our partner, paused the divestment process due to the ongoing operational issues. And as such, we currently expect to hold an interest in Nuclear at the end of 2020. We'll also consider further divestments of other smaller assets or businesses to help to simplify and derisk the group, and we can realize good value for shareholders.

Let me now hand over to Johnathan to cover the numbers, and I'll be back in about 10 minutes.

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Johnathan Richard Ford, Centrica plc - Group CFO & Director [2]

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Thanks, Chris, and good morning, everyone. To 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 realize this potential.

Moving straight into the first half financial results. As you can see from the bottom of the slide, adjusted operating profit was down by 14% to GBP 343 million. 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-19 pandemic and operating profit up 37% to GBP 328 million. 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 GBP 19 million.

Low commodity prices were the main driver of us recognizing GBP 785 million of exceptional impairment in our E&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 10% and 30% since the start of the year. We also booked GBP 251 million 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 GBP 70 million 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-19 was GBP 55 million. I'll cover this off in more detail on the next slide.

The impact of lower commodity prices in the upstream business and a small negative foreign exchange movement reduced profit by a further GBP 207 million. Warmer weather in the first half of 2020 compared to 2019 had a GBP 60 million impact across both the U.K. and North America. The underlying upstream results, excluding the low commodity prices, benefited by GBP 70 million from low depreciation and tight cost control. And underlying consumer performance was encouraging, with operating profit GBP 126 million higher than last year as higher underlying margins in North American business, good trading performance from EM&T in volatile commodity markets and cost efficiencies, particularly in the U.K., services and home solutions, all helped the result.

Let me go into a bit more detail on the COVID-19 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 U.K. 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 U.K. as National Grid dealt with the extreme change in consumption.

Revenues in our services business were also impacted as we prioritized 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 60 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 GBP 60 million, although this is -- 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. 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 GBP 50 million on an annual basis.

In total, these factors negatively impacted adjusted operating profit by GBP 219 million 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 nonessential work again. And this trend has continued into July. Boiler installs are now running at about 2/3 of where we were this time last year. And we now have around 750 employees on furlough, all of them expected to be back in September.

In response, we were able to mitigate the impact of COVID-19 by GBP 164 million through a number of actions, including reductions in discretionary costs, the use of the U.K. job retention scheme and delayed 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-19 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&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 GBP 250 million relating to timing on a number of items, which we expect to reverse in the second half. The largest of these relates to a 1-month deferral of our Danish VAT bill.

CapEx, mainly related to IT spend and upstream investment, 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 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 GBP 750 million compared to GBP 430 million 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 GBP 75 million additional pension contribution made in 2019. As a result, net debt inflow was GBP 593 million. And when taking into account noncash movements, net debt ended the first half at GBP 2.8 billion.

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 end of June, we had GBP 1.3 billion of available cash and GBP 2.9 billion 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 we require 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 GBP 522 million, reflecting a 50 basis point reduction in the discount rate over the past 6 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 GBP 1.4 billion and annual contributions of GBP 175 million out to 2025. On a roll-forward basis using the same methodology from 2018, this technical deficit would be GBP 2.4 billion today. As a reminder, the next triennial valuation is due as at the 31st of March 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.

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Chris O’Shea, Centrica plc - Group Chief Executive & Director [3]

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Thanks, Johnathan. 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 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 million households in the U.K. with one or more of services, gas or electricity. We're the largest energy supplier to residential customers in the U.K. and the second-largest supplier to small businesses. We also provide home services to 4 million households, which makes us, by some distance, the largest player in the country. U.K. services is now our largest business in profit terms. And with levels of customer retention consistently around 80% over the past 15 years, this business provides a predictable and attractive cash flow stream. There are always areas for improvement, but this is a very stable business.

Our integration into British Gas is intended to allow us to benefit from its 1 million active customers without further material cash stream. We retained our top 2 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. First, 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 U.K., 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 our 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 4 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 1 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 1 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 3 management layers in the company.

And number four, we have to modernize to be successful. And I know from past experience, a growing company will be a more fulfilling place to work, more energizing, 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 U.K. is underway, which I recognize 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 a material third-party consultancy spend. We'll accelerate the delivery of our GBP 2 billion cost-efficiency target, albeit in a different way and at a lower cost. By getting this right, we will 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 of what's just been covered, let me briefly summarize what this all means and what we believe the outcome will be.

We have 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 U.K. 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-19 crisis. Our first half is very strong in this regard, but we are not yet out of the woods. Centrica 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&A session shortly.