Centrica Financial Analysis Report basing on the 2014 Annual Report
Centrica is “an integrated energy company which operates in four segments: British gas, Centrica energy, Centrica storage and direct energy. The Company has estimated proven and probable (2P) gas and liquids reserves in Europe, North America and Trinidad and Tobago” (Markets Ft, 2014). Integration is Centrica’s decisive strategy which helps them to grow and diversify their portfolio for value; along the way it reduces risk, adds to scale and reduces cost. This report will analyse the financial performance and position of Centrica using financial statements consisting of the balance sheet, income statement and the cash flow statement; the statements are for the years 2013 and 2012. The accounting ratio calculations are in the appendix. This report will also evaluate if the chairman’s comments about Centrica’s future performance and 2013 performance are supported by the financial information.
Centrica has experienced a mixed year where it has managed to pull off important acquisitions and mergers positioning the group fairly well for the future. However, the short-term outlook has seen profitability fall, the company is more leveraged and dogged with liquidity concerns. All of which are explored in great detail below.
One of the most important accounting ratios ROCE(return on capital employed) has shown a decline of 25% in 2013 compared to 2012. ROCE measures the profitability and efficiency with which capital is employed: capital employed is debt and equity. In 2013, Centrica was 25% less capable of generating more earnings per pound of capital employed. However, this was largely caused by new investments. In the year 2013, Centrica employed capital through asset purchasing of Cuardrilla resources and AJ Lucas group for £44 million in cash. Additionally, it acquired Suncor upstream in a 60:40 partnership, Hess energy marketing for approximately £257 million (100% stake), Bounce energy for £27 million in cash (100% stake) and American water heater rentals 100% interest for £18 million. As a result, of these purchases ROCE was down in 2013 but hopefully, it might increase in the future as revenue from the new ventures begins flowing.
Likewise, the gross profit margin decreased by 14% in 2014. Gross profit margin(GPM) measures the impact of the cost of sales which is mainly downstream business. This suggests that Centrica is having a few problems controlling costs in relation to its core activities and its capacity to pay operating costs and other expenses to build for the future has declined. At the core of its activities, Centrica experienced a 9% increase in its transportation, distribution and metering costs at the same time Centrica also saw a sharp increase of 13% in commodity costs.
This is not good news as its closest rival Scottish and Southern Energy (SSE) recorded strong growth of 39% in the gross profit margin, investors will be watching with a scrutinizing eye.
The operating profit margin (OPM) has also reduced to 7.1% in 2013, a fall of 35% from 2012. Operating profit margin measures what percentage of total revenues made by operating income. The decrease in the operating profit margin is due to an increase in costs relating to downstream business mainly from directors remunerations, share-based payments and pensions entitlements which amounted to £1.9 billion. Coming second, were the increasing volumes of exceptional items which are non-recurring in nature. They include impairment of UK and North American exploration and production assets which stand at £699 million. Additionally, there was also impairments of UK gas storage contracts at £240 million. Altogether exceptional items stood at £939 million pounds having risen briskly by 53% compared to 2012. Investors could be alarmed at the high rate at which operating costs are rising. Nonetheless, it should only be an alarm because Centrica’s business model is to expand through mergers and full-on buyouts for none recurring costs. Since a considerable amount of the costs are one-time only costs, in the long run, a brighter future beacons as the group might experience economies of scale bringing down overall operating costs which means a reduction in the duplication overheads as Centrica’s supply and upstream business will share management and overhead costs.
Although total revenue has increased by 10% in 2013 the net profit margin(NPM) has declined by a considerable 30% compared to 2012. Centrica is less efficient by 30% at converting revenue into actual profit. The decline will increasingly put off investors who want immediate returns on their investments especially when rival Scottish and South Energy produced a whopping 107% growth in net profit margins. They are doing something right that Centrica is doing wrong, investors will recognise that in the short term.
Adding to concerns mentioned earlier, Centrica increased financial risk to its shareholders by increasing borrowing by 10% which means more profits will be eaten up by obligatory interest payments. Further, investors will be concerned by the decline in the return on equity (ROE) which reduced by 14%. For them, this means a reduction in the dividend payout, a substitute company such as SSE that experienced growth of 49% might become an alternative to Centrica. Nevertheless, it is important to remember this is a short term view to take given the new investments Centrica has taken, acquisitions and buy-outs allow Centrica to expand to new markets which might be very profitable in the future.
Centrica’s has experienced restrained improvement in liquidity from 2012. For example, the current ratio rose by 1.07% in 2013; rising to 0.94 in 2013 from 0.93 in 2012. This was mainly principally due to the rise in trade and other receivables by £1.1 billion and a rise of derivative financial instruments by £300 million. Concurrently, current liabilities have grown by a combined £1.3 billion leaving only 100 million to make the difference between current assets and current liabilities.
The quick ratio showed a modest increase of 2.4% ( 85% 2012 to 87% in 2013). Crucially, the ratio is still below 100% which is room breath for Centrica. The increase in leverage was mainly from trade and other payables which amounted to £1.08 billion. These short-term high volume borrowings put Centrica in a difficult position in relation to any future borrowing as increasing cash flow concerns.
Centrica is also taking longer to pay back the debts, taking 6 more days to pay suppliers. Days went from 91 days in 2012 to 97 days in 2013. Future borrowings are a cause for concern as the company might face tougher questioning from creditors and suppliers who take a harsh view to longer payback cycles. Trade receivables days have also increased from 66 days in 2012 to 75 days in 2013, that’s adding 9 more days to receive payments making their cash flow less efficient.
On evaluation, the small improvements in the current ratio and quick ratio are restrained by increasing borrowings and longer trade receivable days affecting short-term liquidity.
Gearing measures to what level a company is leveraged. Centrica is playing a high-risk game, net debt to equity (ND/E) increased by 31% in 2013, rising from 64.6% to 84.7%. The net interest cover has also reduced by 38% from 12.5 times in 2012 to 7.7 times in 2013. The financial risk at Centrica has increased, shareholders will not be too happy about this and the group’s credit rating (AAA) is under threat, which will make future borrowing costly for the group.
Cash flow summary
Cash flow per share measures how much cash per share a business generates after accounting for capital expenditures like equipment or buildings. Cash flow Per share (CFPS) has improved up by 2% in 2013 rising from £0.54p in 2013 to £0.56p in 2013. CFPS is higher than EPS which stands at £0.26 pence for 2013 which is positive news but in the broader picture, it does not address core concerns. Moreover, the actual earnings per share should be £0.18p reflecting true annual performance but the board decided to award £0.26 pence to have growth on the £0.24p awarded in 2012. The board was aggressive and imprudent but compared to SSE plc Centrica’s closest competitor in the industry, has an EPS of £0.44 pence, still offering more value to shareholders.
The chairman Rick Haythornthwaite said, “we have substantially increased the scale of our North American operations and now serve over six million residential and business customers. We have also delivered good strategic progress upstream, despite some setbacks in the UK North Sea, adding reserves organically and through acquisition” (Haythornthwaite 2014). In the medium term, these comments mean little to shareholders who want a quick buck. All they see is profitability decreasing, the group highly leveraged and a shaky future where earnings per share and dividend yields will be weak. The group has taken risks in the form of acquisitions, they have to start paying off soon.
Acquisitions and mergers are normally a sign that an organisation is growing and if expansion is managed effectively Centrica should see profits increase in the long run. Nonetheless, the short-term position needs to be addressed urgently. Increased gearing and weak liquidity may force investors to search elsewhere unless profitability increases significantly. 2014 will be a testing year for Centrica.
Performance (profitability) of Centrica
|ROCE = PBIT/Capital employed X 100%||1892/10429 x 100
|Gross profit margin = gross profit/revenue x100||5395/26571 x 100
|Operating profit margin = PBIT / Turnover||1892 /26571x 100
2625/23942 x 100
(10.96 -7.1) /10.96
|Net profit margin = Net profit /turnover x100||950/26571 x 100
1245/23942 x 100
|Return on Equity = net profit / equity||950/5192 x 100
1245/5927 x 100
Position (liquidity) – short term standing of Centrica
|Current ratio = current assets /current liabilities||7428/7898
|0 :94 :1(0.94)||0 :93 :1 (0.93)||+1.07%
|Quick ratio = current assets – inventory / current liabilities||6898/7898
|0:87:1 (0.91)||0:85:1 (0.85)||+2.4%
|Trade Payable days = trade payables/cost of sales x 365||5630/21176 x 365
4545/18326 x 365
|97 days||91 days||+6.5%
|Trade receivables days = TR/revenue||5446/26571 x 365
4335/23942 x 365
|75 days||66 days||+14%
|Gearing equity = non-current borrowings / equity||5172/5257 x 100
4762/5927 x 100
|Net debt to equity = borrowings less cash/total equity x 100||5172- 719 /5257
|Interest cover = PBIT/ interest paid||1892/297
|6.3 times||9.6 times||-34%
|Net Interest rate cover = PBIT /net interest expense – interest rate income||1892/243
|7.7 times||12.5 times||-38%
Cash flow ratios
|Cash flow per share = net cash flow from operating activities/number of equity shares issued||2940/5183m
Competitor Focus- Scottish and Southern Energy(SSE) plc
- Haythornthwaite, R. (2014). Centrica plc – Annual Report and Accounts 2013 – Introduction – Chairman’s Statement. [online] Centrica.com. Available at: http://www.centrica.com/files/reports/2013ar/index.asp?pageid=16 [Accessed 2 Dec. 2014].
- ft.com, (2014). Centrica PLC, CNA:LSE profile – FT.com. [online] Available at: http://markets.ft.com/research/Markets/Tearsheets/Business-profile?s=CNA:LSE [Accessed 20 Nov. 2014].