1. [1]
Period: 2011 -
2013
Author: Adam Ariff
ACCA number: 2479994
Mentor: Kate West, MMU Business
School
Word count: 7403
Date: May 2014
OXFORD BROOKES UNIVERSITY
Research and Analysis Project
Topic 8
Analysis and evaluation of the business and financial
performance of Centrica Plc.
2. [2]
TABLE OF CONTENTS
1) INTRODUCTION
Project objectives and overall research approach Page
1.1 Project Topic……………………………………………………………………………………………………………………4
1.2 Project Area and Company Selection………………………………………………………………………………4
1.3 Research Aims and Objectives………………………………………………………………………………………..4
1.4 Research Approach………………………………………………………………………………………………………...5
2) INFORMATION AND EVIDENCE
Information gathering and accounting/business techniques
2.1 Sources of Information………………………………………………………………………………………………..…7
2.2 Ethical Issues………………………………………………………………………………………………………………….7
2.3 Information Sources and Methods of Collection…………………………………………………………….7
2.4 Accounting Theory and Business Techniques…………………………………………………………………9
2.4.1 Ratio Analysis………………………………………………………………………………………………….9
2.4.2 Benchmarking………………………………………………………………………………………………..10
2.4.3 Financial and Non-financial Measures…………………………………………………………..10
2.4.4 Further Non-financial Measures…………………………………………………………………...11
2.4.5 SWOT Analysis…………………………………………………………………………………………….…11
2.5 Foreign Currency Exchange……………………………………………………………………………………………12
3) RESULTS & PRESENTATION
Results, analysis, conclusions and recommendations
3.1 Company Profile……………………………………………………………………………………………….13
3.2 Presentation and analysis………………………………………………………………………………..14
3.2.1 SWOT Analysis………………………………………………………………………………...14
3.2.2 Profitability and Return Ratios…………………………………………………………16
- ROE
- ROCE
- Operating Profit Margin
- Gross Profit Margin
3. [3]
- Operating Profit Margin
- Net Profit Margin
- Asset Turnover
3.2.3 Investor ratios………………………………………………………………………………….18
- Dividend Per Share
- Earnings Per Share
3.2.4 Liquidity ratios………………………………………………………………………………….20
- Current ratio
- Quick ratio
- Inventory turnover
3.2.5 Financial Gearing……………………………………………………………………………..21
- Interest cover
3.2.6 Financial Performance vs. Business Performance……………………………21
3.2.7 Comparison and Competition…………………………………………………………..22
- Market capitalisation
- ROCE
- Operating Profit Margin
- FTSE comparison
3.2.8 Non-financial measures……………………………………………………………………24
3.3 Critical Analysis and Evaluation of Results……………………………………………………….25
- SWOT Analysis
- Group performance
3.4 Conclusion and Recommendations………………………………………………………………….27
4) REFERENCES……………………………………30
5) BIBLIOGRAPHY……………………………….33
6) APPENDIX……………………………………….34
4. [4]
INTRODUCTION
(1) Project objectives and overall research approach
1.1 Project Topic
This research project is on topic 8 of the Oxford Brookes project topic areas; an analysis and
evaluation of a business over a three year period. Topic 8 requires the application of a large amount
of knowledge and understanding from the ACCA examinations and syllabus found in modules F1 to
F9. The requirement to produce detailed financial analysis and examine company accounts links in
well with topic 8.
1.2 Project Area and Company Selection
The energy sector is an ethically current topic affecting millions of people across the world. In the
UK British Gas has more company accounts than any other energy provider. British Gas is a
subsidiary of Centrica plc. and during 2013 came under intense scrutiny from the government and
the public because of their increases in energy prices. Further examination of their company
accounts could provide some interesting analysis on whether the recent price rises are justified.
Over the past three years Centrica has made a profit year on year. To put this into context; in 2009
the UK was in recession for the first time since 1991 (BBC, 2009) and many global financial systems
were in crisis which resulted in the UK government spending £50 billion to prevent the financial
system grinding to a complete stop (Weardon, 2009). Whilst many financial institutions continued to
make a loss, as did many businesses, the majority of energy companies continued to make a profit.
This report highlights the profit enabling and sustainable features of the energy industry and
companies operating in the sector, particularly focusing on Centrica plc.
1.3 Research Aims and Questions
The aim of this research project is to review Centrica's performance over three years in comparison
to their competition and from a shareholder perspective.
The report will show the overall trend and pattern of Centrica's business and financial performance
and in order to answer the main objective there have been four research questions selected:
5. [5]
1. What are the trends of profitability and shareholder return over three year period from
2011 to 2013?
2. How have the industry conditions in which Centrica operated in from 2011 to 2013 impacted
on their profitability, their short term solvency and liquidity?
3. What are the causes of the trends in Centrica's overall business performance and financial
performance between 2011 and 2013?
4. How do the trends in Centrica's profitability and return compared to their competition from
2011 to 2013?
By specifically answering these four research questions the overall aim of the project will be met.
1.4 Research Approach
The research conducted will provide both financial and business performance data. Financial
performance relates to the way in which companies earn, save and spend their money over a certain
length of time (Differencebetween.net, n.d.) whilst their business performance measures focus on
the business goals and progression towards those goals. These goals may be non-financial measures
such as customer satisfaction scores or product quality measures (Kellen, 2003). A wide variety of
sources have been used to collect research data for analysis and the company accounts are
predominantly the major source of financial and business performance. The accounts have been
used as a source of quantitative analysis as well as an assessment of the overall business strategy.
The company accounts are split into three sections; business performance, exceptional
items/remeasurements and financial performance. The business performance relates to how the
business performed excluding exceptional items and remeasurements whereas financial
performance takes into account exceptional items.
Industry comparative data and five additional companies have been selected as benchmark data.
Comparative data has been used because this is useful when using ratio analysis, which will form a
large part of the research project. The reason it is useful is because in isolation a ratio can be
misleading; this is because different industries are subject to different forces that influence their
ratios. Parent groups of the big six energy companies in the UK have been selected because they are
all similar in size, in the same industry and in direct competition with each other.
Research framework
Financial performance will be addressed by completing ratio analysis that covers:
Profitability and return
6. [6]
Short term solvency and liquidity
Efficiency (turnover ratios)
Shareholder investment
The scope of the research project will exclude long term solvency and stability because the scope of
the analysis is over three years which is a short term period of time.
In addition to financial performance the report will discuss non-financial measures such as changes
in customer accounts and employee numbers. Other non-financial measures will focus on the
Centrica's strategic priorities over the three years and this will be further analysed using a SWOT
analysis.
The research framework will cover overall performance (financial and business) looking at how
external, internal and competitive factors have influenced this performance.
7. [7]
(2) Information and Evidence
2.1 Sources of Information
The research completed for this report does not contain primary data sources. One of the reasons
for this is because Centrica is a publicly listed company and it is probable that information on the
company that is not confidential is available to the public. All research data and information used in
this report is from secondary data sources.
The majority of data analysed was quantitative data that related to company finances however a
small amount of qualitative data was used such as customer satisfaction surveys for energy
companies.
2.2 Ethical Issues
As a publicly listed company Centrica is bound by the rules and regulations of the stock market. One
ethical consideration around the project was the use of any confidential information. Had my
researched revealed information that was confidential that could have influenced stock market or
share prices this could have raised ethical concerns. However, all research conducted for this report
was from secondary data sources available to all members of the public and this meant there were
no ethical issues around this during information gathering and research.
It is also likely that using a broad mix of information sources have sought to limit any bias in the
report and any information within the report has been produced based on secondary data sources
or expressed as matter of opinion; any user of this report must be aware that their investment
decisions must be based solely on their own judgement and not on the basis of information within
the report should the information not be accurate.
2.3 Information Sources and Methods of Collection
The following information sources have been used and selected carefully because they support the
overall research requirements needed to achieve the research questions.
Company Accounts and Annual Report
Centrica's company accounts and annual reports were analysed in detail and provided a major
source of financial and non-financial data. One benefit of their use as a source of data because they
8. [8]
are required to comply with international accounting standards that made them understandable. In
addition to this they were useful for comparison to other company accounts of competitors. All
company accounts were accessed online.
Stock Exchange Analysis
Centrica is a FTSE 100 company (Yahoo, 2014) that any investors can trade shares in on the stock
market. Pension funds and private investors all invest by buying and selling shares in Centrica daily.
Technical information about ratios and performance existed online and has been used as source of
quantitative data for use in my research. Use of this data is likely to support the view of shareholders
because analysts use this data to support their buy or sell investment decisions.
Published literature and books
MMU Business School Library provided a wealth of literature to support research on ratio analysis in
particular. One advantage of using the library to find sources of information is that they contain
large quantities of literature both historic and current. The ability to cross reference theories and
applications of theories reduced the chance of bias or error when applying techniques such as ratio
analysis.
Regulating bodies
In the UK, British Gas is regulated by Ofgem that have stipulations on the information energy
companies must provide. As an independent regulator the likelihood of research being impartial
should increase and it was used as an independent source of information in supporting claims within
Centrica's annual reports.
Accounting standards
All company accounts were produced in accordance with accounting standards. Detailed research
into the notes of the accounts could be supported through research of international reporting
standards which are set by accounting bodies. As an independent organisation the data approved on
accounting standards used to support financial measurements is likely to be a good source of
objective research.
Published learning media
A lot of published learning media by BPP and Kaplan has content approved by the global professional
body, ACCA. In addition to text books from the library the BPP and Kaplan study guides were
9. [9]
considered to be high quality information and were a source of practical research and theoretical
research. The reason the information was considered to be high quality is that because it is
approved by industry regulators to meet internationally acclaimed academic benchmarks.
Further information sources
In addition to the above sources the following sources were used; reviewed published literature,
journals, news and media via smartphones and company websites. The use of multiple data sources
was to increases the validity of the data thereby limiting bias in the research.
2.4 Accounting Theory and Business Techniques
2.4.1 Ratio Analysis
Ratio analysis as a technique has been used for analysing the company performance because it can
be used in trend analysis to measure year on year performance and also as a comparison across
companies. Investors still use ratios as a source of information for their investment decisions and
financial institutions use ratios to make decisions about the amount companies can borrow. It is
likely that many investors and institutions use ratios because they believe can be a reliable indicator
of company performance. One advantage of using ratio analysis in this report is that all the
necessary information is available to compute the ratios.
Use of specific ratios
Ratios and comparatives that have been selected in the report are those that are generally accepted
as meaningful indictors for each category (BPP, 2011b). Additionally, generally accepted ratios that
are used by analyst have been calculated. These indicators are used to provide investors with
information to make decisions on investments and it is therefore more likely that this systematic
approach would align itself to the overall project aim of reviewing performance from a shareholder
perspective.
Limitations of ratio analysis
Due to changes published by the IASB to IAS 19 that came into effective from 1st January 2013
(Deloitte, n.d.), there has been a material impact on the financial statements for 2012 that has been
retrospectively corrected in the annual account comparative statements for 2013. Where analysis
has been conducted using data from 2012 and the restated results make a material impact on the
findings this has been reflected in the narrative of this report.
10. [10]
Further recognition of the limitations of ratio analysis is that it merely identifies the trend. The
speculation and cause behind the movement in the trend requires further research and some
speculation.
2.4.2 Benchmarking
Ratio analysis has been used to compare Centrica to both the industry and their competitors. There
are a lot of strong arguments when used isolation ratios do not offer much value. The benefit of
being able to use ratio analysis in this report against competitors is that all the competitors are
mandated to produce company accounts. This means that all the information is available to draw
comparison of ratios. Furthermore data from analyst that produce industry specific ratios can be
used for comparison. Research of these ratios, coupled with competitor ratios is useful in
established a standard range to benchmark deviations between performance.
Limitations of benchmarking
Different financing policies and degrees of diversification (BPP, 2011b) can impair the accuracy of
results. Furthermore degrees of diversification can seriously impair the accuracy of benchmarking
against sector specific ratios. Currency exchange is of particular relevance when using comparatives
in the energy sector because some of the research was completed on company accounts that were
produced in Euros rather than British Pounds (see 2.5).
2.4.3 Financial and non-financial measures
The comparatives selected have been chosen because they cover a broad range of areas across all
major parts of the business. Use of multiple comparatives also increases the reliability; this is
because many figures derived from the financial statements, although conforming to the relevant
GAAP, may be subject to different accounting techniques that can lead to different final figures for
profit or net book value of assets. This has been considered when looking at operating profit in
particular. Use of cash flow statements eliminates any variations due to accounting techniques
because it removes any non-cash flow elements, such as depreciation and amortisation when
computing the statement.
Comparison of Centrica's competitors based on company group accounts will be critical in providing
an accurate analysis of their performance. There are a number measures that can be used to
compare businesses. The report will look at the following:
Financial measures: market capitalisation, turnover/revenue, profit and return, company assets and
debt, liquidity
11. [11]
Non-financial measures: number of employees, UK and global coverage/structure
Non-financial measures have been used because the coverage and complexity of an organisation can
be linked to performance. One example of this could be an increase in employees linked to an
increase in demand or production a product or reduction in employees could be due to
redundancies as a result of cost cutting or poor cash flow.
2.4.4 Further non-financial measures
Centrica products are a mix of tangible and intangible products. For example, British Gas supply
boilers to the homes of their customers (tangible) however the supply of electricity and servicing of
these boilers (intangible) is one of their products/services. Delivering energy to over 12 million
customers in the UK, British Gas supplies a considerably higher proportion of customers than its next
biggest competitor SSE with 9.6 million customers (SSE, n.d.). Despite having the largest customer
base British Gas ranked 16 out of 17 in Which Customer Satisfaction Survey 2014 (Which, 2013).
Intangible assets such as the 'British Gas' brand can create loyalty that offsets poor satisfaction rates.
2.4.5 SWOT Analysis
A SWOT analysis provides a framework to evaluate four elements; strengths, weaknesses,
opportunities and threats of a business. A SWOT analysis has been chosen because the analysis links
in well with the research questions. The framework of a SWOT analysis encompasses internal and
external factors across all elements, both of which are considerations in the research questions. The
SWOT analysis also can be used in an omnipresent manner incorporating either historical, present or
future factors into each element. Finally the SWOT analysis recognises competitive factors through
identifying opportunities and threats; this could be useful in addressing the research question
around Centrica's market positioning and performance against their competition. Other analysis
considered was a PEST analysis that also evaluates four elements: political, economic, social and
technological. This analysis focuses more on market conditions and would probably have less
relevance than a SWOT analysis based on the research questions.
Limitations of a SWOT analysis
As with all research methods, the SWOT analysis has some limitations that should be considered
when using it as an assessment tool. A SWOT analysis is a subjective method of analysis; this means
that the factors within each element (strengths, weaknesses, opportunities, threats) are created
with degree of speculation. One example of this is that a factor may be identified as a threat e.g. the
impact on a company of a change in government; this could however be considered an opportunity
12. [12]
based on what that change in government is. Where there is cross over due to the subjective nature
of the analysis this has been recognised.
2.5 Foreign Currency Exchange
All company accounts published in Euros were converted at the Bank of England exchange rate at
date of publication.
13. [13]
(3) Results, analysis, conclusions and recommendations
3.1 Company Profile
The Centrica Group is comprised of four separate businesses that operate through North America,
UK and Europe along with Trinidad and Tobago. Two of these businesses form part of the
international downstream operations of the businesses; these are British Gas and Direct Energy.
Centrica energy forms part of the international upstream operations of the group whilst Centrica
Storage operates offshore gas storage facilities (Centrica, 2014a). Investopedia (n.d.a) defines
upstream activities as, 'Operations stages in the oil and gas industry that involve exploration and
production.' Downstream activities are described as, 'The oil and gas operations that take place after
the production phase, through to the point of sale.' (Investopedia, n.d.b).
Centrica owns a large energy provider in the UK that operates under British Gas and they supply
energy to millions of customers and businesses across the UK. Direct Energy is part of Centrica and
performs a similar operation across North America. In the UK, British Gas is one of six major energy
companies and they are structured as part of a larger parent group in a similar structure to many of
the large six UK energy companies.
Unlike EDF group that predominately buy gas on the wholesale markets (EDF, n.d.), Centrica
subsidiary Centrica Energy, in addition to trading oil and gas, sources and generates oil and gas
which it subsequently supplies to British Gas. The involvement of Centrica in this initial stage to the
end results in customers' homes will be discussed in further details later when analysing the
importance of company structure in the business performance and its relative success.
In the early nineteen-nineties the government controlled the energy industry before privatisation
encouraged a more competitive environment further compounded by ease of switching that was
facilitated by technology, in particular the use of the internet (British Gas, 2013). In June 2000
Centrica announced the acquisition of Direct Energy (Centrica, 2000) which gave Centrica further
opportunity to expand their global operations and remain largely influential in the European energy
market through British Gas and Centrica's other subsidiaries. Today there are 6 major energy
companies classified by Ofgem as the 'big six'; British Gas (Centrica), EDF energy (EDF group), Eon,
npower (RWE), SSE, Scottish Power (Iberdrola). In addition to competing with smaller energy
companies they are continually competing for market share for both residential and business
customers.
14. [14]
3.2 PRESENTATION AND ANALYSIS
3.2.1 SWOT Analysis
As a large multinational corporation in the energy sector Centrica's performance is largely influenced
by macro-economic and environmental factors. A SWOT analysis of the conditions over the past
three years shows a summary of these major factors. The following SWOT analysis aims to highlight
factors that have influenced the results shown later in this section.
Strengths
Seasonal variations in temperature can
influence the energy use of residential and
business customers. This is out of Centrica's
control. A key strength of the performance
in 2012 and parts of 2013 was high levels of
revenue; this was a result of cooler
temperatures in first part of 2013 and
throughout 2012 resulted in higher
consumption
The political landscape in North America
meant that energy companies including
Centrica had surplus supplies of shale gas in
The increase in supply in North America
currently kept and continues to keep gas
prices low resulting in higher profits
Weaknesses
In contrast to the cooler temperatures that
benefited Centrica in 2012 the warmer
weather last quarter 2011 reduced demand
for energy that resulted in lower profits
despite higher prices
Loss of consumer confidence due to prices
rises influenced by global events out of
Centrica's control (Syria crisis)
Centrica was unable to proceed with long
term Baird and Caythorpe gas projects
despite having a high value of committed
costs
16. [16]
3.2.2 Profitability and Return Ratios
ROE and ROCE
The trend in ROE shows growth of 3.8% and 5.27% in 2012 and 2013 respectively. This is a positive
signal because it shows the management are delivering better value for money for shareholders year
on year and delivering a higher return. This has occurred as a result of either higher operating profit
in 2012 or as a result of a reduction in equity in 2013. In 2013 operating profit was in fact lower than
in 2012 but the drop in shareholder equity more than offset the required drop in operating profit
and this resulted in an improvement in ROE. A contributing factor in 2013 to the drop in ROE was
largely as a result of the deduction of £500 million in the purchase of treasury shares along with
deductions of £179 actuarial losses. The impact of IAS 19 adjustment had a non-material
restatement of equity deduction of £20 million. It is unlikely that this will present a risk to the
business. Any readjustment through losses in the reserve has been offset have by retained earnings
adjustments. Additionally the £500 million of treasury shares should not impact on overall business
performance but were repurchased as equity instruments of the company under the share
repurchase programme.
The impact of long term debt can be analysed by comparing the ROCE and the ROE. ROCE employed
remained relatively flat from 2011 to 2012 dropping by only 0.03 % points, however continued to
drop again by a further 0.4% point by 2013. The reduction in ROCE is bad because investors want to
see higher levels of return on capital and not lower returns however the amount in which the ROCE
has been reduced by is unlikely to be significant to investors or lenders in the short term. The growth
in capital employed from 2011 to 2012 was 16% of which 5% can be accounted for in equity and 11%
accounted for by additional financing/debt. In 2012 the increase in long term debt was offset by a
2011 2012 2013
ROE 39.43% 43.23% 48.50%
ROCE 16.60% 16.57% 16.17%
Operating profit 9.67% 10.70% 9.48%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
45.00%
50.00%
55.00%
60.00%
ROE vs ROCE
17. [17]
16% rise in PBIT producing only a small net reduction in ROCE of 0.03%. In relative terms this could
be considered to have remained flat and therefore a within a reasonable variation, however the lack
of growth in operating profit in 2013 combined with a 12% decrease in equity and a significant rise in
company debt has led to a decline in ROCE. A continuing trend could potentially raise the cost of
capital and damage the share price and this is likely to be a contributing factor to the proposed £100
million cost saving exercise in British Gas and $100 million cost saving in Direct energy by 2015. The
movement in ROCE could be attributed partly to Centrica's recent strategy for growth through
acquisition over 2012 to 2013 particularly in North American downstream operations. The increase
in levels of debt may have also prompted Centrica to undertake the £500 million cost reduction
programme successfully implemented over the course of the last 3 years that was completed in
2013 (Centrica, 2014).
Profit margins and asset turnover
Operating profit margins according to Morningstar data (See Appendix) shows average market
specific operating margins of is 12.2 % and Centrica is lagging behind this sector specific margin by
1.5 % to 2.72 %. This is probably not concerning for shareholders because the shortfall against
industry average is not relatively large and Centrica's margins have been consistent over the last
three years. This could actually be a result of the Centrica's position in the market and not having
realised the full profit potential of their recent acquisitions after the expansion of its North American
division.
21.30%
9.67%
5.54%
21.99%
10.70%
5.64%
19.22%
9.48%
5.02%
Gross profit margin Operating profit Net profit
Profit Margins in Centrica 2011 -
2013
2011 2012 2013
18. [18]
Centrica achieved the highest margins in 2012 and their lowest in 2013. However the trend in ROCE
is not consistent with the trend in operating margins, for example, the operating margins increases
in 2012 but the ROCE drops. This inconsistency may be viewed by shareholders as poor
management. Palepu and Healey (2013) explain how margins are influence by 2 main factors, these
being price premium a firm commands in the market for its products or services and the efficiency of
the procurement and production process. Analysis of the company's balance sheet reveals that
margins doe change but improvements in margins are often offset by a reduction in asset turnover.
Year 2011 2012 2013
Asset turnover (ratio) 1.72 1.55 1.71
Sales(i)/capital employed 22824/13299 23942/15460 26571/15568
Profit margin x Asset turnover = ROCE
2011 9.67% x 1.72 = 16.6%
2012 10.7% x 1.55 = 16.58% *
2013 9.48% x 1.71 = 16.21% *
*small difference in results is due to rounding
Indicates an increase in value from previous year
Indicates a decrease in value from previous year
In 2012 Centrica's increase in operating margin is offset by a reduction in asset turnover and in 2013
an increase in asset turnover is offset by a decrease in margin. It could be possible that the volatility
of the energy sector margins are heavily influence by the economy and global commodity costs and
variations in the weather may play a significant role in rate at which Centrica turnover their assets.
3.2.3 Investor Ratios
The year 2012 marked the thirteenth year in succession that Centrica was able to pay a full year
dividend rate at or above the rate of inflation (Centrica, 2013). Over three years from 2011 to 2013
Centrica has increase their dividend per share (DPS) year on year from 15.4p to 16.4p and 17p for
2011, 2012 and 2013 respectively and this is considered a positive signal by shareholders. Centrica's
19. [19]
earnings per share (EPS) increase in 2012 and decreased in 2013 but it is likely that the dilution in
earnings per share is viewed as bad news by shareholders. The increase in DPS does not match the
earnings made by Centrica year on year or the share price of Centrica stock over that three year
period. Possible reasons could be due to Centrica's requirement to attract investors and the impact
of paying a lower dividend on their cost of capital. Centrica is owned by the shareholders but
controlled by the management team who have a fiduciary duty to govern the business in an ethical
and responsible manner with a view towards making a profit. The importance of generating profit is
significant for a FTSE 30 company such as Centrica because they need to be able to make a profit
consistently in order to pay a sustainable dividend. Centrica is owned by over 700,000 individual
shareholders and numerous pension fund investors (Centrica, 2014a). The importance of
shareholder funds and subsequent share price of Centrica can therefore directly impact the pension
funds of millions of individuals and investor confidence will be heavily influenced by both Centrica's
profit and their ability to pay a sustained dividend.
Further analysis of investor ratios show that Centrica's performance between 2011 and 2013 was
mixed with basic EPS peaking at 24.6p in 2012 and dropping to a low of 8.2p in 2011. It is of
significant to shareholders that DPS has increased despite the basic EPS not increasing every year.
Basic earnings are simply a representation of the earnings generated by the company but may not
necessarily be attributed the overall aim of maximising shareholder wealth (Kaplan, 2012). Investors
are interested in the income earned by the company for them and their return on investment
(Kaplan, 2012). Shareholders will be concerned with financial performance in addition to business
performance. This is because the financial performance is ultimately the basis of which Centrica can
pay a dividend. Whilst EPS shows a spikey profile over the three year period the DPS shows a steady
2011 2012 2013
Basic EPS 8.2 24.6 18.4
DPS (pence) 15.4 16.4 17
0
5
10
15
20
25
30
Pence
Centrica EPS against DPS from 2011 to 2013
20. [20]
and consistent increase over the period. It is likely that the steady growth on DPS reflects the
necessity of Centrica to maintain investor confidence and any decrease in DPS is often regarded as a
form of information about the company's performance (Kaplan, 2012). This would also explain the
lack of a significantly higher dividend payment in 2012 despite making a significantly larger profit
than the year before. A large pay out in 2012 may have affected Centrica's ability to maintain a slow
and steady DPS in 2013 which in turn may have affected shareholder confidence.
3.2.4 Liquidity Ratios
In 2012 Centrica's current ratio increased from 0.893 to 0.946 reflecting Centrica's increase in assets
being greater in proportion than the increase in their liabilities. In 2013 the current ratio remained
relatively flat with 2012 showing the proportion of current assets remained consistent with the
proportion of current liabilities. The analysis shows between 2011 and 2012 the current ratio and
quick both increased however in 2013 the current ratio decreases and the quick ratio increases. The
quick ratio gives an indication of the ability of the company to meets its debt from all current assets
less inventory so the improvement in the quick ratio is likely to be viewed as positive because
Centrica is less reliant on inventory to meet their debt obligations. In 2012 Centrica considerably
increased their inventory levels by 23% from 2011. This movement is as a result of increased gas in
storage and transportation (Centrica, 2014a) and storage of a higher volume of other raw materials
and consumables. Higher levels of inventory are likely to have contributed to higher profit levels
which in turn reduced Centrica's reliance on inventory meet their debt obligation. An increase in
inventory turnover from 8.98 2011 to 10.65 in 2012 along with additional inventory investment most
likely played a significant role in improving final profit.
2011 2012 2013
Current ratio 0.893 0.946 0.940
Acid ratio 0.822 0.862 0.872
0.750
0.800
0.850
0.900
0.950
1.000
Ratio
Centrica's current ratio vs quick ratio from 2011
to 2013
21. [21]
Factors that may influence the movement in both these ratios include the political agendas and
seasonal gas prices spread which contributed to increased storage in Centrica Storage. The existing
quick ratio is significantly higher than the average energy sector current ratio of 0.33 according to S
& P 500 data (CSI Market, n.d.) which is good and could be as a result of high levels of trade
receivables due from the British Gas. The level of receivables is affected by seasonal variation in the
weather and the number of British Gas and Direct Energy's customer and business accounts year on
year.
3.2.5 Financial Gearing
Centrica's interest cover has increased from 6.17 to 8.48 in 2011 and 2013 respectively. In 2012
Centrica saw a reduction in their interest cover to 6.07 but the presentation of their restated results
in 2013 showed a significantly different figure of 9.79 (9.79 restated 2012). This is due to an
amendment to IAS 19 regarding employee benefits and the measurement of certain interest costs.
3.2.6 Business Performance vs. Financial Performance
Based exclusively on profit and margins Centrica achieved their best results in 2012 (2012 restated
results show business performance highest in 2013 due to adjustments made in accordance with IAS
19). Overall business performance remained relatively flat over the three years from 2011 to 2013.
This is a large contrast to Centrica overall financial performance. These results will provide
shareholders with confidence about the ability of the business to perform but because dividends and
earning are calculated based on financial performance they may have concerns. In 2010 Centrica
outlined its strategy to:
2011 2012 2013
Business
performance
1252 1350 1333
Financial
performance
442 1273 950
0
200
400
600
800
1000
1200
1400
1600
Fmillion
Business peformance vs Financial
Peformance
22. [22]
(i) Grow British Gas
(ii) Deliver value from our growing upstream business
(iii) Build an integrated North America Business and
(iv) Drive superior financial returns
(Centrica, 2012)
The impact of this strategy, point (iv), could have had a significant on the financial returns achieved
by Centrica. Porter (1985) describes 3 generic competitive strategies, one of which is overall cost
leadership. Similarities of this strategic style can be drawn to the aggressive three year cost
reduction programme to save £500 million. In 2011 exceptional items in relation to this strategy of
£154 million restructuring charge, £333 million adjustment to final pensionable salaries and decision
to move out of the German wholesale business leading to £111 million loss to the business all
affected overall financial performance. Furthermore despite relatively strong performance in 2013
the change in their strategic priority and desire to increase returns through capital discipline may
have influenced the decisions to downgrade resources across the UK and North America that
resulted in £699 million in impairment losses. Further political pressures ruling out gas storage
incentivisation from the government impacted a further £240 million in impairment losses.
3.2.7 Comparison and Competition
Based on the market capitalisation of the parent groups owned by the top six energy companies
Centrica ranks as the fourth largest. Centrica's recent strategic priorities to innovate and drive
growth and service excellence along with integrating their natural gas business linked to their core
markets could be linked to their growth strategy and the need to maintain their competitive position
against companies with a much larger market capitalisation.
23. [23]
Analysis of the financial performance show market capitalisation has little correlation to the ROCE
however it does show that the levels of return of Centrica are far higher than the results of the other
five major UK energy suppliers parent group. Generally speaking market capitalisation can be used
as a reasonable measure of risk and rewards with smaller cap company's having larger potential for
growth with higher risk and as such may be seen as a less conservative investment (Standards &
Poor's, n.d.). As all of the companies market capitalisations are above £10 billion they all fall into the
same category of large-cap companies and could therefore be considered to be low risk investment
(Standards & Poor's, n.d.). In contrast to Standards & Poor's publication (Standards & Poor's, n.d.)
the results show both the fourth and fifth ranked groups (Centrica and SSE) have returns on capital
as high as 17.75%, over 3 times more than the average ROCE of some of the large market capped
companies. This could be a result of Centrica and SSE's heavy involvement in downstream activities.
The top 3 companies, EDF group, EON and Iberdrola consistently deliver higher levels of profit than
the other groups but equally employ more capital. If managed well, higher levels of capital should
result in higher profits however the top three companies have a lower proportionate return overall.
The charts below show a comparison of the capital employed, the operating margin and ROCE of the
big six energy parents companies supporting the above narrative.
16.88
43.79
22.48
13.43
14.40
25.91
0.00 10.00 20.00 30.00 40.00 50.00
Maket cap (£bn)
£ bn
Top 6 UK energy company (parent group) market
capitlisation(Exchange at 0.826EUR to GBP based on BoE exchange
rate at 26/04/2014)
Iberdrola
SSE
RWE
Eon
EDF Group
Centrica plc
25. [25]
3.2.8 Non-financial measures
Centrica operates a strong upstream operation and employs in the UK alone nearly as many
employees as Iberdrola do globally. Furthermore Centrica employ 174,000 employees compared to
156,168 working for the EDF group. This is a staggering amount considering the EDF group over
twice the size of Centrica by market cap. Additionally there is a dramatic difference between the
smallest of the six large groups which is SSE at 20,000 employees. The large differences could reflect
the more complex and technical operations around exploration and production that Centrica are
more heavily involved with.
Centrica's 2013 annual accounts depict a clear strategy that emphasises the necessity to respond to
the competitive market through improving key metrics like Net Promoter Score and leading the
market in Green Deals and on political change. The growth in the use of technology such as Hive
Energy coupled with an increase in pre-payment services and offering of additional services such as
home warranty in the US reflects Centrica's ambition to both empower customers and drive down
the cost for the customer. The strong emphasis Centrica has placed on leading the market on
modernisation is likely to ensure that any political or macro-economic pressures will not adversely
influence their margins, share price and overall return.
3.3 Critical Analysis and Evaluation of Results
Overall profit has been shown to peak in 2012 along with ROE, however ROCE remained relatively
flat and then dropped in 2013. Centrica's annual reports' link temperature to residential and
household energy use stating that cold temperatures result in higher bills and warm temperatures
result in lower bills and revenue. Data according to the Met office shows 2011 had the second
warmest year since records began. 2012 and 2013 has equally cool temperatures and these were
ranked in the top three of the coolest in the last sixteen years (Met Office, 2011). Whilst
performance cannot exclusively be attributed to the weather, there does appear to be some
correlation and the overall performance in 2011 and 2012 appear to be indicative of the mean
temperature pattern. The impact of the weather is cited in 2013 annual reports as a contributing
factor to poorer performance in downstream operations. Whilst a late winter may have delayed cold
temperatures this should have been offset by an exceptionally cold spring (Met Office, 2014),
indicating that the presence of additional factors in the poorer performance in downstream
activities and overall group performance; these factors could relate to government political agendas
influencing demand.
26. [26]
42%
42%
3%
13%
Group operating in 2011
profit split by subsidiaries in
£m
British Gas
Centrica
Energy
Centrica
Storage
Direct
Energy
40%
45%
3%
12%
Group operating in 2012 profit
split by subsidiaries in £m
British Gas
Centrica
Energy
Centrica
Storage
Direct
Energy
38%
49%
3%
10%
Group operating in 2013 profit
split by subsidiaries in £m
British Gas
Centrica
Energy
Centrica
Storage
Direct
Energy
Group Performance
This table shows the operating profits from 2011 to 2013 against their competition.
2011 2012 2013
Centrica
plc. 1,414 2,625 1,892
EDF
Group 6,981 6,810 -
Eon (757) 4,667 5,165
RWE 3,410 3,175 105
SSE 2,368 534 800
Iberdrola 3,720 3,614 2,010
Furthermore analysis of the Centrica's overall results from the above table support a view that
Centrica's ability to support profit and drive efficiencies within the group by delivering both
upstream and downstream activities may have stabilised their profits. At a time when energy and
wholesale costs were increasing in 2012 and 2013 Centrica was able to offset the loss in their
downstream activities particularly across British Gas with a higher proportion of profit derived from
upstream activities in Centrica Energy as detailed below.
27. [27]
Unlike Centrica, EDF Trading (a subsidiary of EDF group) manages a portfolio of assets to source,
supply, and transport (EDF, n.d.) in addition to other activities across the value chain. Trading in gas
does not eliminate the risk of a decrease in downstream activities because they are unable to offset
against upstream activities and EDF are not significantly involved at the very beginning of the value
chain in the exploration and production process. RWE delivers the second highest return and based
on and are involved in projects in upstream gas supply through the Breagh offshore gas field (RWE,
n.d.). As drilling work only began in 2012 further analysis in future years would be able to determine
whether the combination of upstream activities and downstream activities does influence the
overall ROCE.
Other influences
EDF has in recent months experienced a surge in investor confidence and a rise in their share price
as a result of political decisions made by the French government to allow an increase in regulated
electricity prices (Young Alice, 2013) and reflect the potential impact governments can play in
influencing investor confidence.
3.4 Conclusion and Recommendations
The project aim was to review Centrica's performance over three years in comparison to
their competition and from a shareholder perspective; this is addressed by answering four research
questions as detailed in section 1.3. The research questions focused around financial performance
and measured Centrica's business performance against their strategic priorities. Additionally the
report draws comparison of Centrica's performance benchmarked against their competition and
industry averages.
Profitability, return and investment
From 2011 to 2013 the results have been mixed with Centrica having their best results (based on
profit) in 2012. The variations in profitability over the three years is most likely as a result of changes
in Centrica's operating margins and their asset turnover, with each offsetting changes in the other
across the three years. It is likely that an increase in Centrica's investments, particularly acquisitions
in North America may have caused an impact on profit but more importantly may have impacted on
a decrease in the return on capital employed.
The return for the shareholders is not necessarily indicative of performance. Shareholders have
continued to receive a consistent rise in the dividend payments based on their shareholdings despite
overall earnings per share dropping. One likely reason for this is to ensure higher levels of investor
28. [28]
confidence and the keep cost of capital down whilst waiting until longer term investments through
recent acquisitions can be realised.
Liquidity and solvency
Centrica has strengthened their liquidity and solvency ratios by turning over a higher level of
inventory and increasing their assets in greater proportion to their liabilities over the three year
period from 2011 to 2013. Despite having greater levels of debt they have been able to improve
their overall position to meet their interest charges, although this is in part due to a change in
accounting standard IAS 19. They have been able to do this against a changing political landscape,
fluctuating commodity prices and increasing competition particularly in the UK. Centrica appear to
have benefited from their cost saving programme of £500 million over the three year period.
Influence on results
Centrica's group structure has most likely been crucial to Centrica's performance and market
position over the past three years. As their margins and profits are squeezed in downstream
activities they have been able to absorb the reduction by higher margins in upstream activities. With
an exploration and production history dating back to 1985 (Centrica, n.d.a) Centrica has been able to
capitalise on growth of up to 50% (Centrica n.d.b) in production of gas and oil in recent year.
Furthermore Centrica have recognised the need to expand their repertoire of products in both the
UK and North America downstream operations to assert a point of differentiation and are planning
to increase consumer confidence by utilising recent smart technology such as their Hive system.
Recommendations
The energy industry is likely to be put under increasing pressure to operate ethically in terms of their
impact on the environment and their product pricing for customers. Upstream and downstream
activities across the Centrica group are relatively equally split accounting for half of the profit of the
group each. One method of improving the levels of return despite increasing levels of debt could be
by placing emphasis on saving costs in addition to increasing revenue from recent acquisitions.
Political awareness is essential, especially in light of the election in the UK in 2015. The UK may
benefit from low wholesale energy prices as seen in North America if the UK government agree to
further exploration of shale gas in the UK. By increasing their product and services Centrica's
downstream operations could benefit from higher consumer confidence and lower energy prices
which may result in British Gas reclaiming some of their lost business and residential accounts in
recent years. Their performance over the coming years will be largely influenced by their ability to
29. [29]
maintain high levels of revenue across all four segments of the group and if achieved could align
their earnings growth with the demanded for growth by both private and commercial investors.
30. [30]
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Consolidated statement of financial position
Year ended 31st December Business performance £m
Exceptional items and certain
remeasurements Results for the year £m
2013 2012 2011 2013 2012 2011 2013 2012 2011
Group Revenue 26,571 23,942 22,824 - - - 26,571 23,942 22,824
Cost of sales before exceptional items
and certain remeasurements (21,464) (18,676) (17,959) - - - 21,464 18,676 17,595
Exceptional items - - - (125) (89) (221) (125) (89) (221)
Remeasurements of energy contracts - - - 413 603 (437) 413 603 (437)
Cost of sales (21,464) (18,676) (17,959) 288 514 (658) (21,176) (18,162) (18,617)
Gross Profit 5,107 5,266 4,865 288 514 (658) 5,107 5,780 4,207
Operating cost before exceptional
items (2,735) (2,844) (2,750) - - - (2,753) 2,844 (2,750)
Exceptional items - - - (939) (445) (110) (939) (445) (110)
Operating costs (2,735) (2,844) (2,750) (939) (445) (110) (3,674) (3,829) (2,860)
Share of profits/(losses) of joint
ventures and associates, net of interest
and taxation 146 140 93 25 (6) (26) 171 134 67
Group operating profit 2,518 2,562 2,208 (626) 63 (794) 1,892 2,625 1,414
Financing costs/interest expense (297) (437) (358) - - - (297) (437) (358)
Investment income/interest income 54 254 212 - - - 54 254 212
Net finance costs/interest expenses (243) (183) (146) - - - (243) (183) (146)
Profit before taxation (continued operations) 2,275 2,379 2,062 (626) 63 (794) 1,649 2,422 1,268
Taxation on profit (continued operations) (942) (1,029) (810) 243 (140) (16) (699) (1,169) (826)
Profit from continuing operations after
taxation 1,333 1,350 1,252 (383) (77) (810) 950 1,273 442
Profit from discontinued operations - - 13 - - 22 - - 35
Loss on disposal of continued
operations - - - - - (56) - - (56)
36. [36]
Discontinued operations - - 13 - - (34) - - (21)
Profit for the year 1,333 1,350 1,265 (383) (77) (844) 950 1,273 421
Attributable to:
Owners of the parent 1,333 Not available Not available (383) Not available Not available 950 Not available Not available
Earnings per share Pence Pence Pence
Basic 18.4 24.6 8.6
Diluted 18.3 24.4 8.5
Interim dividend paid per ordinary
share 4.92 4.62 4.29
Final dividend proposed per ordinary
share 12.08 11.78 11.11
37. [37]
Centrica balance sheet
31st December 2013 2012* 2012 2011
Non-current assets
Property, plant and equipment 7,446 7,965 7,965 6,412
Interest in joint ventures and associates 2,658 2,721 2,721 2,620
Other intangible assets 1,905 1,579 1,579 1,221
Goodwill 2,819 2,543 2,543 2,518
Deferred tax assets 105 183 183 235
Trade and other receivables 150 55 55 74
Derivative financial instruments 227 313 313 290
Retirement benefit assets 205 254 254 413
Securities 202 199 199 190
15,717 15,812 15,812 13,973
Current assets
Trade and other receivables 5,446 4,335 4,335 4,212
Inventories 530 545 545 442
Derivative financial instruments 573 268 268 315
Current tax assets 151 54 54 81
Securities 9 7 7 28
Cash and cash equivalents 719 931 931 518
7,428 6,140 6,140 5,596
Assets of disposal groups classified as held
for sale 301 - - -
Total assets 23,446 21,952 21,952 19,569
Current liabilities
Derivative financial instruments (506) (615) (615) (1,140)
Trade and other payables (5,630) (4,545) (4,545) (4,094)
Current tax liabilities (645) (594) (594) (226)
Provisions for other liabilities and charges (258) (266) (266) (308)
Bank overdraft, loans and other borrowing (859) (566) (472) (502)
(7,898) (6,586) (6,492) (6,270)
Net current liabilities (470) (446) (352) (674)
Non-current liabilities
Deferred tax liabilities (1,426) (1,678) (1,678) (1,506)
Derivative financial instruments (431) (327) (327) (505)
Trade and other payables (64) (26) (26) (33)
Provisions for other liabilities and charges (2,394) (2,480) (2,480) (1,903)
Retirement benefit obligation (165) (166) (166) (83)
Bank overdrafts , loans and other
borrowing (5,172) (4,762) (4,856) (3,669)
(10,192) (9,439) (9,533) (7,699)
Liabilities of disposal groups classified as
held for sale (99) - - -
44. [44]
Centrica cash flow statements
Year ended 31 December 2013 2012 2011
Group operating profit including share of results of joint ventures
and associates 1,892 2,625 3,299 Cash generated from continuing operations
Less share of profit of joint ventures and associates (171) (134) (262) Petroleum revenue tax paid
Group operating profit before share of results of joint ventures and
associates 1,721 2,491 20 Interest received
Add back/(deduct) (3) Interest paid
Depreciation, amortisation, write-downs and impairments 2,319 1,507 (194) Payments relating to exceptional charges
Profits on disposals (21) (38) (430) Income tax paid
Increase in provisions 162 201 -
Defined benefit pension service cost and contributions (87) (52) -
Employee share scheme costs 43 43 -
Unrealised gains arising from remeasurement of energy contracts (400) (610) -
Operating cash flow before movement in working capital 3,737 3,542 -
Decrease/(increase) in inventories 78 (88) -
Increase in trade and other receivables (456) (205) -
Increase in trade and other payables 697 361 -
Operating cash flow before payments relating to taxes, interest and
exceptional charges 4,056 3,610 2,360 Cash flow from continuing operations
Taxes paid (892) (524) -
Payments relating to exceptional charges (224) (266) (23) Cash flow from discontinued operations
Net cash flow from operating activities 2,940 2,820 2,337
Purchases of businesses (1,115) (155) (394)
Sale of businesses 140 30 78
Purchased on intangible assets and property, plant and equipment (1,615) (2,367) (299) Purchased of intangible assets
Sale of property, plant and equipment and intangible assets 17 14 6
Investment in joint ventures of associates (51) (291) (236)
45. [45]
Dividends received in joint ventures and associates 193 110 147
Repayments of loans to, and disposal of investments in, joint
ventures and associates 59 42 10
- - (765) Purchase of plant, property and equipment
Interest received 29 33 6
(Purchased)/sale of securities (8) 26 48
New cash flow from investing activities (2,351) (2,558) (1,399)
Issue and surrender of ordinary share capital and share awards 20 24 23 Issue of ordinary share capital
Purchase of treasury shares under share repurchased programme (502) - (6) Purchase of own shares
Distribution paid to NCI (8) - 9 Financing interest received
Financing interest repaid (248) (215) (202)
Repayments of borrowings (400) (516) 59 Cash flow from increase in debt
Cash received from borrowings 1,209 1,712 (28)
Foreign exchange loss on cash settlement of
derivative contracts
Equity dividends paid (862) (815) (762)
Net cash flow from financing activities (791) 190 (907)
Net (decrease)/increases in cash and cash equivalents (202) 452 30
Cash and cash equivalents at 1 January 931 479 451
Effect of foreign exchange rate changes (10) - (2)
Cash and cash equivalents at 31 December 719 931 479
Included in the following line of the group balance sheet:
Cash and cash equivalents 719 931 518
Bank overdraft loans and other borrowing - - (39)
719 931 479
![[1]
Period: 2011 -
2013
Author: Adam Ariff
ACCA number: 2479994
Mentor: Kate West, MMU Business
School
Word count: 7403
Date: May 2014
OXFORD BROOKES UNIVERSITY
Research and Analysis Project
Topic 8
Analysis and evaluation of the business and financial
performance of Centrica Plc.](https://image.slidesharecdn.com/fe90ff67-52cd-4941-8ef5-3075c3f3aef2-160427201426/85/centrica-financial-account-report-1-320.jpg)
![[2]
TABLE OF CONTENTS
1) INTRODUCTION
Project objectives and overall research approach Page
1.1 Project Topic……………………………………………………………………………………………………………………4
1.2 Project Area and Company Selection………………………………………………………………………………4
1.3 Research Aims and Objectives………………………………………………………………………………………..4
1.4 Research Approach………………………………………………………………………………………………………...5
2) INFORMATION AND EVIDENCE
Information gathering and accounting/business techniques
2.1 Sources of Information………………………………………………………………………………………………..…7
2.2 Ethical Issues………………………………………………………………………………………………………………….7
2.3 Information Sources and Methods of Collection…………………………………………………………….7
2.4 Accounting Theory and Business Techniques…………………………………………………………………9
2.4.1 Ratio Analysis………………………………………………………………………………………………….9
2.4.2 Benchmarking………………………………………………………………………………………………..10
2.4.3 Financial and Non-financial Measures…………………………………………………………..10
2.4.4 Further Non-financial Measures…………………………………………………………………...11
2.4.5 SWOT Analysis…………………………………………………………………………………………….…11
2.5 Foreign Currency Exchange……………………………………………………………………………………………12
3) RESULTS & PRESENTATION
Results, analysis, conclusions and recommendations
3.1 Company Profile……………………………………………………………………………………………….13
3.2 Presentation and analysis………………………………………………………………………………..14
3.2.1 SWOT Analysis………………………………………………………………………………...14
3.2.2 Profitability and Return Ratios…………………………………………………………16
- ROE
- ROCE
- Operating Profit Margin
- Gross Profit Margin](data:image/gif;base64,R0lGODlhAQABAIAAAAAAAP///yH5BAEAAAAALAAAAAABAAEAAAIBRAA7)