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Centrica feels the heat

Warmer weather conditions have heaped more pressure onto Centrica's margins.
November 26, 2014

Following the announcement by rival electricity provider SSE (SSE) that its earnings will remain fairly static this year, Centrica (CNA) issued a profit warning citing mild UK weather having pushed down energy consumption in the second half of the year to date.

IC TIP: Hold at 286p

The British Gas owner revised down its full-year adjusted earnings per share for 2014 to 19-20p from the 21-22p expected at the time of its interim results in July. Above average temperatures during the year to date, compared with unusually cold conditions in 2013, resulted in a 21 per cent and a 7 per cent reduction in residential gas and electricity consumption respectively for British Gas during the first 10 months of the year.

This is coupled with a 4 per cent reduction in nuclear output during the same period after its Hartlepool and Heysham 1 power stations were shut down in August when a crack was discovered in a boiler spine at the latter site.

Notwithstanding the nuclear output issues, the warmer weather conditions are likely to hit the wider electricity generation sector as well. Indeed, analysts expect the warmer weather to push down full-year margins across the sector but Liberum analyst Peter Atherton says Centrica will be particularly hard hit by the warmer weather since its year end falls in the middle of winter. He reckons SSE's full-year profits may be able to recover as long as the milder weather does not persist into January and February.

Centrica's profit warning followed SSE's first-half results earlier this month, which revealed a 10 per cent drop in operating profits to just under £431m largely due to a reduction in domestic power demand. As a result SSE's chairman, Lord Smith of Kelvin, said adjusted EPS for 2014-15 would be towards the lower end of the range set out in March.

Meanwhile, electricity providers have much more than the effect of the weather on their margins to think about. The Competition and Markets Authority (CMA) is expected to release the initial findings of its investigation into the energy market in January, which could further squeeze margins and hamper sentiment.

But despite this, utilities analyst at broker Whitman Howard, Angelos Anastasiou, still rates Centrica as a buy. He says the looming outcome of the CMA investigation has already been priced in by the market and that Centrica's underlying financials are sufficiently robust as a cash generator. Likewise, Mr Atherton reckons the group is a buy, since he believes it will show more discipline with its surplus cashflow going forward, after previously purchasing several upstream assets that did not perform as well as expected.