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Morningstar | Centrica Warns on 2019 Cash Flows; Risk of Dividend Cut Increases

Centrica warned on 2019 cash flows, increasing the risk of a dividend cut. The 2018 dividend is confirmed at GBX 12 per share. We expect to cut our fair value estimate by a low-double-digit rate on this publication. For the moment, we reiterate our GBX 160 fair value estimate and no-moat, stable trend rating. We recommend investors owning shares to keep them.

2018 adjusted EPS decreased 10% to GBX 11.2 versus guidance of GBX 11.5 and our GBX 11 estimate. The most disappointing performance was again the North America business division, whose underlying EBIT margin came in at 0.9%, well below our 1.5% estimate. Management blamed fierce competition and the timing effect of capacity charges. We will lower our long-term margin forecasts for the unit. Otherwise, most other businesses performed in line with our expectations. Notably, U.K. home energy's EBIT fell 19%. Churn amounted to 6% and significantly slowed at the end of year, which is positive. For 2019, Centrica indicates that the tariff cap will have a pretax impact of GBP 300 million, of which GBP 70 million is one-off, roughly in line our estimate. Factoring in lower structural margins in North America business and the recent decline in commodity prices will decrease our net income and fair value estimate by a low-double-digit rate.

The risk of a dividend cut has increased. Against a set of unusual challenges in 2019, the group is guiding for adjusted operating cash flow of GBP 1.8 billion-2 billion, which jeopardizes the target of average AOCF over 2018-20 of GBP 2.1 billion-2.3 billion. Since this is one of the two required conditions to maintain the dividend, that implies a risk of a cut. Without scrip, a dividend cut of one third to GBX 9 would save around GBP 200 million of cash. Management will provide more clarity on that front at the half-year results in July, highlighting its lack of visibility on the business outlook.

In any case, management's priority is to protect the balance sheet and maintain the credit ratings. Accordingly, the group unveiled a GBP 500 million divestment program in 2019, to which GBP 230 million corresponding to a U.S. retail services business has already been agreed. This divestment program should offset the cash flow shortfall, keeping net debt at GBP 3 billion-3.5 billion, consistent with the midpoint of the 2018-20 range after IFRS 16 adjustment. Also, Centrica's 20% share in EDF's U.K. nuclear plants is still up for sale.

The group targets GBP 250 million of cost savings in 2019 and an additional GBP 500 million beyond 2019. Altogether, cumulative cost savings since 2015 would amount to GBP 1.75 billion. We should not materially change our estimates on that as we believe the bulk of the efficiencies will be absorbed by challenging business conditions, in line with what has happened since 2015. Remarkably, cost savings enabled unit margin per customer account to be flattish since 2015 despite multiple headwinds.