On the day British Gas and France's EDF became the last of the big six energy companies to announce cuts in their household gas prices, shares in Centrica (CNA) and SSE (SSE) fell to new 12-month lows. SSE had already outlined a 5.3 per cent reduction in its domestic gas prices at the end of January, shortly after German energy company E.ON announced similar cuts. British gas owner Centrica's 5.1 per cent reduction on all residential tariffs is the third price cut announced by the utility group since the beginning of last year. But how much impact will the cuts have on these UK-listed energy groups' earnings?
Cutting prices on residential gas bills will naturally eat into SSE and Centrica's downstream income. But it shouldn't have too much of a detrimental impact on their profits since the rationale behind the cuts is to pass on lower wholesale gas prices to consumers. Notably, SSE and Centrica will implement the price falls from 29 and 31 March, respectively, after the colder winter months where energy usage is typically higher. Whitman Howard utilities analyst Angelos Anastasiou believes cutting residential power bills is a smart move given the political climate around utility companies. "It's also a sensible thing to do in any case, especially when you have the CMA investigating you with the power to bring all prices down," said Mr Anastasiou.
The fact is that both companies have bigger fish to fry. Both share prices have been weighed down by weak commodity prices, which have, in turn, sparked broker downgrades. Yet this has left SSE and Centrica trading at 12 times and 11 times Bloomberg's consensus forward earnings, respectively.
RBC Capital Markets analyst John Musk thinks Centrica, in particular, needs to reassure the market on the downside risk to its EPS and the robustness of the dividend in the face of weak commodities. But he remains positive on the British Gas-owner, placing an outperform recommendation on the shares and a target price of around 260p.
Centrica's strategic operational and investment shift towards its customer-facing businesses, which include British Gas, Irish Bord Gais and US-based Direct Energy has been received favourably by analysts in light of the risks facing its upstream operations. The move away from exploration and production has also enabled the group to cut costs, with management targeting £750m in cost efficiencies by 2020.
Rival SSE has been viewed less favourably. Some analysts argue that the group's sizeable networks business, which accounted for just over half the group's capital expenditure during the first half of the financial year at £403m, prevents it from making the same cost cuts as Centrica. However, Mr Anastasiou points out that the regulated side of SSE's business is not necessarily a negative. "Yes, the wires and pipelines business is more capital-intensive, but it is also more safe and stable, that is the classic utilities business," he said.
However, one thing neither SSE nor Centrica can get away from is the tightening cover on their dividends. SSE's interim dividend announced in November was covered 1.4 times by earnings, yet some analysts are predicting this to fall to 1.3 times by the time of its full-year results in May. Analysts at RBC Capital are forecasting Centrica's dividend will be around 1.3 times for 2015.
