Centrica plc (CNA) Earnings Call Transcript & Summary

Good morning, everybody. It's Chris O'Shea from Centrica here. I'm joined by Johnathan Ford, our new CFO, who's been with us 6 weeks; and by Scott Wheway, our Chairman. So hopefully, you've had a chance to see our results, to see the announcement about our disposal of Direct Energy and also to watch our presentation. And with that, very happy to move into -- take any questions that you've got.

[Operator Instructions] And the first question is from Mark Freshney of Crédit Suisse.

On the pension deficit, your sale circular or sale document -- towards the back, it talks about some restrictions and agreements that you've entered with the pension fund trustees on regarding deficit or potential deficit repairs. Can you talk through the issues surrounding that and whether you're potentially only on the hook for the GBP 1.4 billion now? Or whether the pension fund trustees would demand that it's actually the current GBP 2.4 billion that's relevant here? So that's my first question. Secondly, on British Gas and the higher consumption and price caps, just what -- your predecessor spoke about targeting a 3% margin. I just want to understand if that's still the case within British Gas Residential? And I guess my third question is on your services business. Your services business, clearly, Johnathan, you came from the major competitor of British Gas, which showed a lot more growth than British Gas Services. Can you talk about what your expectations might be for that business in the medium term regarding growing the top line rather than cost-out and what you think you might be able to do with it?

Mark, thank you very much. I'll try and take the pension deficit restrictions question you've just asked. And then Johnathan will -- can talk about services. So the deficit we had on a technical provisions basis at the 31st of March '18 was GBP 1.4 billion. If you roll forward the assumptions to today, recognizing things like the discount rate, et cetera, that deficit would be GBP 2.4 billion. And so it's very important that obviously it's different to the IAS 19 deficit, I think, because one uses essentially government discount rates and one uses AA corporate bonds. So that's the first point. The restrictions that have been entered into with the pension trustees is obviously we anticipate making a substantial contribution to the pension scheme from the proceeds of the Direct Energy disposal. We haven't yet agreed the level of that contribution. And we'll enter into negotiations with the trustees in the intervening period and hopefully have that before completion of the transaction. But in advance of that, we have agreed to a couple of restrictions. One of the restrictions is that we won't make any excess distributions or special distributions to shareholders before we've agreed the size of the contribution into the pension scheme. And the second thing is that we also won't undertake any accelerated debt repayment, again, until we've entered into agreement with the pension scheme. And so those are the restrictions that are referred to in the document. So we'll enter into discussions with them and agree the level of contribution. But the reason for sharing the GBP 2.4 billion is simply that, their like-for-like comparison to the GBP 1.4 billion. That does need to be funded over time if there's no other changes in the external metrics of [ this gives ], et cetera. But it doesn't need to be funded from this transaction. So your second question was in terms of the higher consumption and the price cap in the margin. So obviously, we still target the 3% margin that we are permitted to make up under the cap, including some headroom that we've got there. We have seen consumption increase in our residential business over the lockdown, not very much in gas. But we've seen higher electricity consumption, but it hasn't offset the reduction that we've seen in the B2B space. And so both in British Gas and in Direct Energy home, residential demand has gone up a bit. But both in what was U.K. business and what was North American business, the drop in demand has more than offset that increase in demand. So net-net, we have seen a reduction due to the impact of COVID. And then on the services question, I'll pass it on to Johnathan, so he can give you his views.

Thanks, Chris. The first thing I would say on services is I think it's been a very resilient performance in the first half. You can see that in the numbers that have come through with the U.K. home business up 27%. I think that speaks to a very stable business with high levels of retention and recurring revenues. So that, as you've quite rightly pointed out, is the model that HomeServe had. I think when you talk about the growth from HomeServe, that was mainly an international story. I think if you look at the U.K. picture there, customer numbers are flat to slightly down, but profits have increased a little bit. And I certainly think, with intentionally looking at the services business there, I think this is a services business that can grow its profitability. I think there are opportunities to improve retention. It's always much more efficient and cheaper to retain a customer than go buy within the marketplace. So I think we can do more there. I think we can also drive our customer service up. I think we've performed well to date. But I think there's more to do there. I think technology can help us do that. We're investing to allow us to do that. And I think we're also moving more customers online. That migration has also increased in the last 6 months. And that's a channel that customers like to use and are happy to use. So I think there's a number of opportunities for us to move that business forward.

The next question is from Jenny Ping of Citi.

A couple of questions from me, please. Firstly, just going back to the cost savings from the restructuring you've announced a couple of months back in terms of the redundancies and the potential cost savings that could come through from that. Should we -- or how should we think about the cost savings falling through the bottom line going into '21? Or are we really going to be seeing all of that savings plow back into the business in terms of coming up with more price-competitive products, et cetera, so actually it's much more focused on customer retention rather than seeing the benefit on the bottom line? I'm just thinking about this in the context, obviously, you've got the dilutive impact coming through from the disposal, how we should marry those 2 up on your bottom line earnings. Any views there would be appreciated. Secondly, just on HomeServe, following the earlier question, could you give us an update on where we are on the FCA investigation and the result of potentially coming up with elements that could increase the competition here? And then lastly, Chris, you said in your video recording that there's potential for further smaller assets that could be put up for sale in the coming months to try and continue to simplify the business. Can you give us a feel of what they are or what could be the areas that they fall in?

So thanks, Jenny. So look, dealing with the last question first, the point is that we will actively manage our portfolio. We've demonstrated that this morning obviously with the disposal of Direct Energy. We have, in the past -- we could be accused of having overpromised and under-delivered. So what I would rather do is to tell you what we've done rather than tell you what we're going to do. So I wouldn't speculate on what assets we may or may not dispose of. But we will manage this portfolio for value. And there are some things that we could consider selling. But if you would bear with me, we would prefer to do what we did this morning, which is to let you know when we've done something. On the cost savings, I mean, how do we think about this? So we are accelerating the GBP 2 billion program. But you're right in terms of will it all fall through to the bottom line. And this is not profit support. This is about us being way, way more competitive. And so we will happily invest some of this in customer retention and in growing the business. But I wouldn't speculate at the moment as to how much goes where. I mean the reason that we're doing a restructuring is to make this a far simpler business. We have -- as you saw in my presentation, way too bureaucratic, top-heavy. It's a difficult place to navigate. We're going to cut through all of that, and we're going to make it easier for people to work here, which will make them -- give them more time to think commercially and sell more to customers. So we've got to get away from cost-cutting and giving them the profit support, and therefore, very happy to reinvest some of this in the customer experience and then growing retention and then also growing customer numbers. So I can't give you a number as to what will fall through, you'll have to make your own judgment on that. And on the FCA investigation, could you just repeat your question? I wasn't sure that I got the whole part of the question.

The FCA was investigating how the industry -- the insurance industry is able to price more competitively. And they were supposed to come out with a decision in June as far as sort of where to implement, whether it's to put some sort of price cap in or to enforce churn a bit like the price cap really on the energy side. Do we have any update on that?

Yes. I don't have any update whatsoever. Yes, I have to say I think actually it's delayed and they said it will come out later in the year. I suppose with many people there have been impacted by COVID. So there's no update on that. I'm sure that you will find out at the same point in time that we find out. I mean our drive and our belief is to provide good value to all of our customers and to make sure that everybody gets value for money, no matter how long you have been with Centrica and British Gas in home servicing. So I'm hopeful that any regulator will be able to see that.

The next question is from Dominic Nash of Barclays.

Congratulations on the sale of Direct Energy. So 2 questions for me, please. Firstly, on the proceeds, you say you're going to pay down debt. But you've got quite long-dated debt. Will you be using the proceeds to call in longer-dated debt? And what sort of exceptional charges will we be looking at there? And then on the second question is almost at the race to the bottom. You're putting in quite a big cost-cutting program. You're facing fierce competition. Your customer numbers are down. I think they're 2% in retail in 6 months. You're saying you're introducing a BGX to sort of come up some low-cost option. With that, are you, a, are we actually going to start seeing in this environment a collapse in your competitors? I mean with the way the world is going, are you starting to see the competitive pressure disappearing as they, themselves, get under pressure? Or secondly, are you at risk of everybody just going down the same route and we end up with a similar sort of insipid margin forevermore whilst everybody puts the same sort of cost-cutting processes in?

There's a lot to unpack in here, Dom. So first, I will give a very high level comment on the proceeds and the debt, probably the next one. And then Johnathan will jump in if I've got anything wrong on the debt. But we published our annual report there, and if you look at all of our debts, you guys know all the -- [indiscernible], so you could [ always do adjustment ] as to what something we'd call if we were to prepay them. But just to remind you, we signed the deal to sell Direct Energy. We've got to get approval from our shareholders. We've got to get approval from antitrust authorities and other regulatory approvals in the States. And so we do have some time to think about this. But you'll be able to price in any of that and yourself. In terms of that race to the bottom and BGX, I'm obviously not a competitor, so we have seen quite some price competition in the past few months. And we have been more disciplined in the UK in that if people want to sell energy at a gross loss, then they're welcome to that business. That's not business that we want and it's not a sustainable position. So the competition hasn't eased, but the market practices are such that you cannot -- I mean if you sell it at a gross loss, you're basically paying someone to take the product. And that's not good business and won't last in the long term. So I wouldn't want to talk too much about our competitors other than to say I don't think anyone can expect to survive if you pay someone to take the product off them. There has been some relief obviously through COVID. You've had the various government support schemes. And for some of the small suppliers that were unable to access the government fund schemes, they have been able to defer their network charges to the national grid. So that has provided them with a capital inflow if they so choose to take that. And that's attractive interest at 8%. And that was a change to the rules introduced by Ofgem. And so companies can access that. You can make your own judgments to whether or not that's a good idea. But it's very much a temporary measure. So we're in the market for the long term and are indeed disciplined in our pricing but we will be competitive as well. BGX is not a different brand. This is -- what we've been doing is if you take a step back in our UKB division, a couple of years ago, we tried a digital-only platform and we called it BG Lite. Pretty successful, we've got over 30,000 customers on that. And so we built something in an agile way, test and learn. And then we've got some success there. We decided a few months ago to replicate that in the residential business. And again, to test that and get a proof of concept to see how that works. Probably not digital-only, probably digital-first, but we believe that customers still want to be able to pick up the phone. So what we're doing here is looking to see what kind of platform alternatives can we have. And we've got over 10,000 customers, I think, on the BGX platform. And so we're learning a lot. So we'll do this. We'll learn. We'll make amends and adjustments and we'll continue to move forward. It's all about giving the customer a better experience. It's all about making sure that customers can access our team in the way that they wish. In the first half through COVID, we saw 2/3 of our transactions in British Gas actually carried out online, which is tremendous. So there's an appetite to do things online. And what we're trying to do is to satisfy that customer demand.

The next question comes from the line of Deepa Venkateswaran of Bernstein.

So there's probably a bit of overlap with the previous questions, but just I wanted to focus on the use of proceeds. So firstly, I wanted to say that it's a great thing to have simplified the business and the valuation seems to be definitely better than what we were expecting. But just wanted to understand what might be below-the-line adjustments that might come through because of the sale. So particularly on the pension side, if you do manage to contribute a chunk of this towards reducing your technical deficit, does that mean that we might see any benefits below the line? Because above the line, it seems like it's a 3p hit to earnings going forward. So just wanted to understand the nuance. And of course, then if you're going to buy back any bonds, one would have to see and there'll be a hit. So that's basically the main question I had really is how should we look at the divestment below the line and above the line?

So Deepa, on that, I'm looking at Johnathan. I'm getting a nod here. I mean it's the same answer I suppose to the last one in terms of below the line. So I mean we've just signed this transaction. Obviously, we know our debt portfolio. We know how we could retire debt. But you can make the judgment. And that moves about, but obviously if this fee rate moves then the price of any buyback could move. So rather than speculate, I think what we'd have to do is to wait and see where the market was at the point that we completed this transaction. The contribution to the pension scheme, we are talking about substantial contribution, but we will negotiate with the pension scheme on the best way for us to do that. So I think that you'll just have to make your own judgment on that. But the proceeds will go -- stay on the balance sheet either through a reduction in debt or a contribution to the pension scheme. And in our view, both of those quite similarly, they are both essentially debt. So that's how we think of that. In terms of the comment, I think I mentioned that Direct Energy contributed [ I said, around the quarter ], 26% of our pretax operating profit last year. So you can run that through yourself. You know the U.S. tax rate [ how the ] tax payment in the U.S., not in the U.K., but you'll be able to do work that through.

The next question is from Martin Young of Investec.

Three quick questions, hopefully. The first one on dividends. You've said in the Direct Energy document that you would look to reinstate dividends when it is prudent to do so. I just wondered what, if any, restrictions there are currently in place preventing you from reinstating those dividends. Obviously, the Ts and Cs of Direct Energy and the relation with the pension funds appear to place some restriction but presumably not a total barrier. But also anything that you may or may have done with the various support mechanisms offered by the U.K. government, so just interested in that sort of ballpark picture there. Secondly, Chris made comments about sort of slimming down the range of offers from home services, specifically referencing EVs and heat pumps. Just wanted to be clear on whether you saw those as being a key part of your offering going forward or something that might be done on a low-touch basis with less priority. And then the final question, an accounting one. Note 6C in today's release sets out a value of GBP 44 million for the recoverable estimate on E&P. Is that a number that relates to your 69% stake after all decommissioning liabilities and net cash or net debt positions at Spirit have been taken into account?

Thank, Martin. And thank you very much for that very detailed accounting question, which Johnathan will be no doubt delighted to take. But let me start with heat pumps and the like. And let me talk about restrictions in dividend. But then I'd like to ask our Chairman to give you -- because I think we've got the Chairman here. And ultimately, dividend is the Board's decision. So I'll give my view and Scott can add on the view of the Board and then we can go to Johnathan in terms of accounting notes. So look, I mean, I mentioned heat pumps. I think the possibility of hydrogen [ heat pumps ], economies for energy management, electric vehicles, et cetera. The point to make is that we are technology-agnostic. We have a great in-home servicing business and we have a great relationship with customers and we're the U.K.'s largest energy supplier. Now I think that as we move to decarbonization, we'll have a mix of technologies. So I think that you'll find the air source heat pumps and then you'll find hydrogen heat pumps. And I think it's entirely possible that hybrid will become part of the energy mix. And the point is that we are very well placed to both enable that and benefit from that. So we're not going to throw our weight behind any one technology over another because I don't think we know any better than anybody else. But these are great opportunities for us as we move forward and I'm actually very excited about the opportunity that we see in this. And therefore, we'll keep it under review and we will be fast followers such that we'll make sure that we understand what technology is going to take and we're very well positioned for that. But we're not going to take a position pushing one technology over the other. This is really down to what the government wants to drive in policy and what our customers want. And what our customers want we'll be able to provide them. So I'm very excited about that. On the dividend, on your specific question about what restrictions do we have, other than the undertaking we've given not to pay excess capital distributions until we've agreed the level of contribution to the pension scheme, we have no restrictions on our dividend. So we are free, but we're also prudent. And we all recognize the importance of distribution. But I think it's probably best for us to take advantage of the fact that our Chairman, Scott Wheway, is here. So Scott will share his view and the view of the Board.

Thanks for the question. Look, let me just underline what Chris described to you. The Board is acutely aware of how important the dividend is to Centrica's investors and to Centrica's stock. But frankly, Chris and I are in violent agreement that the truth is that Centrica recently has had a bit of a history of overpromising and under-delivering. And so we want to be very cautious and very prudent in the way that we proceed. And if you look at the amount of uncertainty that's ahead of us over the next 6 months, Chris has been through the steps that are required in order to get the deal we've announced today completed. The COVID remaining shadow across our business, and in particular, across bad debt, where we're all cognizant of a lot of studies that show what a lagging impact bad debt can be when we looked at previous crises. We've come to the view that right now, there's too much uncertainty for us to say any more, other than to give you the reassurance that we understand how important the dividend is and we hope to able to say more as soon as we can in the future.

Thanks, Scott. And on that, you win the prize for the most detailed read of the results. I'll pass it over to Johnathan to give you a high-level response. But I would suggest if this gets into any detail, it's probably best to take this one offline. So I'll ask Johnathan to do that. But in the interest of time though, we'll see if he can give detail on questions [ from the call ].

The next question is from Fraser McLaren of Bank of America.

I hope you're well. Just 4 very brief questions for me, if I may. First, I'd just like to get your views on the extent to which the sale of Direct Energy will impact on the outlook for the Business Solutions division, especially as you have identified North America as a key market there? And also for connected homes, I know it's not a U.S. angle, but just wondering what your view is on connected home and whether or not that also should form part of the portfolio in the future. Then on nuclear, just wondering when the pause in the process becomes a stop because you can't sell it and your views on whether Hunterston will return. And then just in terms of uncertainties in the second half, I understand your views on bad debt. Just wondering if there's anything else there that you worry about, in particular, in relation to the remainder of the year?

Thank you. I'm wondering whether it's concern, but [indiscernible]. So Martin came up with 3 and you came up with 4, if somebody comes up with 5 I think you're all trying to trump each other. Look, on the -- let me take them in order. So the extent the sale of Direct Energy impacts on Centrica Business Solutions. So Centrica Business Solutions, when we have activities, we have people who have boots on the ground in the U.S. That's not part of this disposal. So we decided to retain that. We do see this as a strong market going forward. Undoubtedly, it -- there was some co-selling opportunities with Direct Energy, which we no longer have once -- we will no longer have once we sold the business. But we still see the opportunity for us to grow Centrica Business Solutions in North America. We think we can do that without having a large energy supply business there. If we are right, then we'll be very happy. And if we're wrong, then we'll no longer have it. So what we won't do is fund lots of losses for a long time. So we have a view and time will tell whether that's right. But you can be sure that we -- and hopefully, you see that, that we will take action and decision very quickly. So we'll watch this and then decide what to do. But I think this is a good business we've got out there. In terms of Hive, what you call connected, I call it Hive. We've got good products there. This, in my view, will never be a material contributor to profit in and of its own right. But customers that have Hive [indiscernible] the retention level is higher, the satisfaction is higher, et cetera, and customers that take Hive and services and energy probably have some of the best customer satisfaction there. So what we've done is that's no longer a business unit and that's already -- the steps have already been taken. It's part of British Gas. It's in a business unit and it's a product that we've got in there. So we think we can benefit -- with over 1 million active customers with that, we think we can benefit from that as part of the British Gas portfolio without further material cash stream. Again, if the hypothesis isn't right, then we won't continue with that. So what we won't do is continue to throw money at this. But there is definitely some benefit there. But it's more as a customer experience benefit, customer retention benefit rather than as a standalone business unit, so it's no longer a separate business. In terms of nuclear, when did a pause become a stop. I mean that's a good question. I think -- I don't have a view on whether Hunterston will return to service, other than if it could be returning service safely, then I'm confident that the regulator will get to a place where we can do that. If it can't be returned to service safely, then we and EDF as a partner, we wouldn't want to have done it ourselves. So we obviously have a view that is revised case-to-case [indiscernible] operate it safely. We've got to reach agreement with the ONR. And if we can, we'll start. And if we can't, then it goes without saying that we won't. You've got to remember that a lot of value in this portfolio sits in Sizewell, so it's a different kind of technology. So we'll undoubtedly see some issues -- the issues we've got in Dungeness and Hunterston. Whilst they're different issues, they are in the older plants. And so we just want to see whether we can get these things in a common position with the regulator, get them up and running again. If we can, we can proceed with the [ sales ] we've got. If we can't, we either can decide to retain this or we can proceed potentially to a different type of sale. For what we've agreed with EDF is it doesn't make sense for us to continue to try to sell something. I wouldn't be over the moon to buy an asset if it wasn't working. And I wouldn't pay top dollar for that. And therefore, let's just take the time to figure out what the future holds and then make a decision at that point. Your last question, what worries me? I mean Johnathan can talk about bad debt levels and the like. I'm equally worried about the impact of -- potentially of COVID, and specifically I'm worried about a mass unemployment event. That's the thing that worries me most. So if our underlying business is strong, the economy is strong, there's lots people losing jobs and can't pay their bills, then that's more problematic. In the U.K., I mean, bear in mind, it's now effectively a regulated market. And so it's not simply that we have massive risk here. There's also risk in terms of -- for the regulators. So this is one of the few areas we've having a regulated cap market actually it can work reasonably well. Because there are mechanisms for recovering things like bad debt. Obviously, it's not a straight pass-through. But there are some protections in there. So I'm worried a little bit about that. But other than that, I actually feel very optimistic about the opportunities that we've got ahead. What we found during COVID is when we have had to, we can work really very differently. So our customer services were always in the office. And now they're all at home. And so that opens up a huge amount of possibilities for us. Our ability to do things quickly, we've demonstrated that with the Direct Energy sale. We're demonstrating that with a number of other things as well in terms of the restructuring. We can move really quickly. So I think a lot of our colleagues have learned just how to do things differently. So I'm actually quite excited about that. But the macroeconomic environment is clearly something that we'll worry as we go forward, but we can't really -- we cannot control that. So all we can do is make sure that we're very, very well prepared. And as I mentioned, 15,000 colleagues working from home every day and the system resilience, touch wood, working fine is really a very useful piece of learning. Just the week I took over, we were planning on running a test to see how many people could work from home. And we weren't sure which half of our building in Windsor to send home to see whether the system could cope with it. And I was quite nervous about what each department would find. But then we had to send everybody home and we found it could work with 15,000 people. So through events like this, you learn a lot. And so I'm really actually optimistic about what we can do going forward, but [ I don't mean ] what is the economic backdrop. But maybe Johnathan can talk a bit about bad debt specifically and our worry around that.

Yes. So with bad debt, we took an extra charge of about GBP 60 million in the first half. I'd say that our provisioning rates for the half year are pretty good, and they stack up to where we were with the financial crisis back in 2009. So I think we're on the right side. Going forward, who knows. The risk we feel is bigger in the second half as the government job retention scheme unwinds, but it's just difficult to predict. It's a real judgment at this point. I think the other big unknown is the impact on energy demand we saw in the first half, the lower demand in our B2B businesses impacting quite significantly. And that, combined with the need to unwind the hedges and sell the energy back, that cost us as well. So again, that's a big unknown. Clearly, there's a reoccurrence of COVID. That's also a risk.

The next question is from John Musk of RBC.

Just 2 questions from me. Slightly repeating, unfortunately. But on the dilution impact from the U.S. sale, you're obviously not giving direct guidance on what you're going to be doing with the proceeds other than saying there's a large chunk to go to pension. But if we were to think about the right level of debt hedged for the business going forward, maybe you can give some sort of guidance there because the EBITDA level post the U.S. sale is perhaps, in round numbers, around GBP 1.5 billion. How much debt do you think you can carry in this business post the U.S. sale? And then secondly, on the Nuclear disposal, I don't know how much color you can give, but the political situation with China is obviously deteriorating. Are there buyers that are outside of China that you could be discussing the Nuclear business with? Or is it all Chinese counterparties?

So thanks, John. Let me take the second one first. So I wouldn't want to speculate on who may or may not be buyers, but I would say that there are more buyers for nuclear power businesses than Chinese buyers. So I'm quite confident about that. So we work with interest what the U.K., Chinese governments are doing just now. But that is not -- that has no impact on our -- had no impact in our decision and has no impact going forward. If Chinese buyers are not acceptable then, such is life, it just means it's a smaller buyer pool. So on that, we will see how that plays out. On the dilution impact, what's the right level of debt going forward? So normally, net debt to EBITDA is a very, very good measure. But when you've got an E&P business that's got a huge capital investment profile and a lot of depreciation challenge, it's a less relevant measure. So I think that if we didn't have Spirit Energy, then we would have -- we'd have an easier way to talk about dealing. But at the moment, you need to just be able to say we will carry the appropriate level of debt on the balance sheet. But what should be clear is that we anticipate the entire proceeds from the disposal will be held on the balance sheet, either to pay down net debt or to make a contribution to the pension scheme. So that's how we intend to use the full $3.6 billion disposal proceeds.

And Chris, I think in any event, our leverage ratios will be materially improved as a result of this transaction.

The next question is a follow-up from Mark Freshney of Crédit Suisse.