Centrica plc (LON:CNA), today announced Preliminary results for the year ended 31 December 2018
Iain Conn, Group Chief Executive
“Centrica’s financial performance in 2018 was mixed against a challenging external backdrop. At the headline level, adjusted operating profit was up 12% and adjusted operating cash flow and net debt were within our target ranges. However, volumes in Spirit Energy and Nuclear were disappointing and recovery in North America Business was slower than expected. Our 2019 financial performance will be impacted by the UK default tariff cap and continuing lower volumes in E&P and Nuclear, meaning our 2018-20 target range for average adjusted operating cash flow is under some pressure. We are taking actions to strengthen the company in 2019 and improve underlying performance in 2020, including driving cost efficiency hard and delivering further divestments, and as a result net debt levels remain underpinned. We have developed material new customer-facing capabilities in both Consumer and Business, exposing Centrica to an expanding opportunity-set, with encouraging indications of stabilisation and growth potential. Our focus is on performance delivery and financial discipline as we satisfy the changing needs of our customers”.
HEADLINES
Key financial messages
· Adjusted gross margin up 5% and EBITDA up 15% relative to 2017. Adjusted operating cash flow of £2,245m up 9%, within targeted £2.1-£2.3bn range. Group net debt of £2,656m, within 2018 targeted range of £2.5-£3.0bn.
· 2018 full year dividend per share of 12.0p.
· Adjusted operating profit up 12% to £1,392m, with higher commodity prices and strong Rough gas production benefiting E&P despite disappointing volumes in Spirit Energy.
· £248m of in-year efficiency savings in 2018, taking total cumulative savings since 2015 to £940m. 2018 exceptional restructuring charge of £170m taking total exceptional restructuring costs 2016-18 to £486m.
· Adjusted EPS of 11.2p, down 10% compared to 2017, including a higher adjusted tax rate of 41%.
· 2019 AOCF impacted by the UK default tariff cap, continued lower E&P and Nuclear volumes, and cash tax phasing. Targeting 2019 AOCF in the range £1.8bn-£2.0bn.
· 2019 net debt expected to be in the range £3.0bn-£3.5bn, consistent with the mid-point of our 2018-20 range when adjusted to reflect the adoption of IFRS 16.
Further actions to improve performance and maintain a strong balance sheet
· Targeting £500m of non-core divestments in 2019, with the £230m sale of Clockwork Home Services business in North America already agreed, in line with intention to drive channel and brand rationalisation across the Group.
· Capital reinvestment in 2019 expected to be £1bn.
· A further £250m of efficiency savings expected in 2019 and an additional £500m targeted beyond 2019 which will take annualised total savings to £1.75bn relative to a 2015 baseline.
Strategic development
· Material new capabilities in Centrica Consumer and Centrica Business with encouraging signs of stabilisation and growth potential. Total Consumer account holdings down 1% in 2018. Customer growth in Ireland, UK and North America Services, Connected Home and Distributed Energy & Power.
· Portfolio simplification continues including through Nuclear sale process and £500m divestment programme.
· Spirit Energy focus on performance and strengthening the portfolio, while limiting Centrica exposure and creating options for the future.
OVERVIEW
Centrica’s financial performance in 2018 was mixed, against a backdrop of volatile commodity prices, extreme weather patterns, continued competitive pressures and political and regulatory scrutiny and intervention. Despite disappointing volumes from both Spirit Energy and Nuclear and slower than expected recovery in North America Business, adjusted gross margin, EBITDA and adjusted operating profit all increased. Adjusted operating cash flow and net debt were within our targeted 2018 ranges of £2.1bn-£2.3bn and £2.5bn-£3.0bn respectively.
Operationally, safety performance was varied. The total recordable injury frequency rate was slightly higher than in 2017, significantly due to musculoskeletal injuries in our smart meter installation operations in the UK. However, process safety outputs continued to improve, with a tier 1 & 2 process safety incident rate of 0.06 per 200,000 hours worked compared to 0.14 in 2017. This reflects major improvements at our operated E&P assets, in particular at Morecambe and Rough. In terms of customer service performance, Brand net promoter scores (NPS) were broadly stable overall while total energy supply complaints were lower overall across the UK, Ireland and North America in 2018 compared to 2017. In UK services, we experienced an increase in customer complaints following extreme cold weather in Q1, although these returned to more normal levels in H2.
In 2019 we continue to face a number of challenges. Our 2019 adjusted operating cash flow will be impacted by the UK default tariff cap which was introduced on 1 January 2019, including an unexpected one-off impact of £70m in the first period of the cap. In addition, Spirit Energy volumes are expected to remain in the lower half of its 45-55mmboe range, nuclear volumes remain impacted by current outages while cash tax will be higher than in 2018 reflecting the timing of payments. These impacts will be partly offset by cost efficiency. Taking these factors into account, we are targeting 2019 adjusted operating cash flow in the range £1.8bn-£2.0bn, which is below the targeted range of £2.1bn-£2.3bn on average over 2018-20.
Against this backdrop, we are taking a number of further actions to strengthen the company in 2019 and improve underlying performance in 2020. These actions also underpin our 2018-20 target of maintaining Group net debt in the range £2.7bn-£3.7bn, which has been updated to reflect the adoption of IFRS 16. They include divestments of non-core positions totalling £500m, of which the first £230m has already been achieved through our disposal of the Clockwork home services portfolio in North America. In addition, cash capital investment including any small acquisitions is expected to be around £1.0bn in 2019.
The actions also include further cost efficiency delivery. Having achieved £248m of cost efficiency savings in 2018, taking cumulative savings relative to 2015 to £940m, we are targeting a further £250m of savings in 2019 meaning we will have achieved our 2018-2020 target one year early. We are also targeting an additional £500m of annualised savings beyond 2019, as we target becoming the “most efficient price setter” in our chosen markets. This would take total efficiency programme savings since 2015 to £1.75bn. These actions will underpin our performance, resilience and competitiveness against a challenging and uncertain backdrop.
Our strategic direction remains aligned to external trends, despite regulatory challenges and falling energy use per unit gross domestic product in our core markets. Our propositions are shifting towards what customers need and want and are not limited to energy supply. We are now exposed to an expanding opportunity set, in terms of customers, channels and geography. We have built material new capabilities in Centrica Consumer and Centrica Business and are seeing indicators of stabilisation and growth potential.
We continue to improve and simplify our portfolio of businesses, with non-core divestments and the ongoing Nuclear disposal process. We are also focused on improving the performance and sustainability of the Spirit Energy portfolio, while limiting Centrica’s exposure to the sector and creating options for the future. Overall, our focus remains on performance delivery and financial discipline as we continue to satisfy the changing needs of our customers.
2018 FINANCIAL PERFORMANCE
Centrica Consumer
Centrica Consumer adjusted operating profit of £750m was down 15% compared to 2017.
UK Home energy supply adjusted operating profit reduced by 19%, with the benefits of cost efficiency delivery more than offset by the negative impact of a full year effect of the UK prepayment cap, which was implemented in April 2017, higher imbalance charges and a lower average number of energy account holdings, largely reflective of competitive market conditions.
UK Home services adjusted operating profit was down 18%, with extreme cold weather in February and early March resulting in additional one-time call out and associated costs of around £20m. In addition, we invested for growth in areas including the on-demand Local Heroes platform and the integration of our Connected Home ‘Boiler IQ’ and ‘Leak Plan’ propositions.
Ireland adjusted operating profit was down 6%, but as expected delivered an improved financial result in the second half of the year. This reflects the return to service of the Whitegate gas-fired power station in May, which had been off for its first major maintenance outage since it was commissioned in 2010 during much of the first half of the year.
North America Home adjusted operating profit was up 8% despite less favorable weather conditions for energy supply, reflecting cost efficiencies, improved services performance and the full year impact of our exit from the loss-making residential solar business in H2 2017.
Connected Home gross revenue was up 60% and adjusted gross margin was up 63% compared to 2017, reflecting an 19% increase in the number of new customer additions over the year, a 37% increase in product sales and a 34% increase in revenue per new customer added. The increase in adjusted gross margin and lower adjusted operating costs resulted in the business reporting a lower level of adjusted operating loss than in 2017.
Centrica Business
Centrica Business adjusted operating profit of £121m was down 25% compared to 2017.
UK Business adjusted operating profit recovered to £40m, compared to £4m in 2017, reflecting further cost efficiency, stable account holdings and no repeat of the negative impact of electricity cost volatility in H1 2017.
North America Business also reported increased adjusted operating profit, up 14% to £81m. When excluding the impact of a one-off non-cash charge in 2017 of £62m relating to a reassessment of the historic recognition of unbilled power revenues, underlying adjusted operating profit fell by 39%. This reflected competitive market conditions and the expected squeeze on retail power net margins on multi-year fixed price contracts signed in earlier periods due to the timing effect of capacity charges in the US North East. However, we are seeing a return towards more historically normal unit net margins in future years, with 2019 margin under contract at the end of 2018 ahead of where 2018 margin under contract was at the same time last year.
Distributed Energy & Power (DE&P) revenue was up 14% and adjusted gross margin up by 35%, but we reported an increased adjusted operating loss reflecting continued revenue investment for growth.
Energy Marketing & Trading (EM&T) adjusted operating profit from its core activities of route-to-market services, trading and optimisation and LNG increased, reflecting strong trading performance particularly during periods of cold weather and commodity volatility in H1. However, as indicated in the 2017 Preliminary Results, our legacy flexible gas contracts were loss-making compared to profitable in 2017 and as a result EM&T adjusted operating profit fell by 48%.
Central Power Generation adjusted operating profit fell by 23%, reflecting the impact of lower nuclear volumes due to extended outages at the Hunterston B and Dungeness B power stations.
Exploration and Production
Exploration & Production (E&P), which includes Spirit Energy and Centrica Storage (CSL), delivered adjusted operating profit of £521m in 2018, up by £320m or 159% compared to 2017. This reflects materially higher gas production from CSL’s Rough asset, with CSL making an adjusted operating profit of £184m compared to £17m in 2017. It also includes the impact of higher achieved gas and liquids due to higher wholesale commodity prices. In addition, Spirit Energy production was up 6%, although after excluding the impact of the consolidation of the Bayerngas Norge assets, underlying production fell 10%. These factors were more than enough to offset a return to more normalised levels of exploration activity in Spirit Energy, which resulted in increased dry hole costs.
E&P adjusted operating cash flow of £963m was up by £454m compared to 2017, which includes the impact of the timing of tax payments relating to 2018 profit which are likely to be paid in 2019. With total capital expenditure of £497m, within Spirit Energy’s targeted £400m-£600m range, the E&P business delivered £483m of free cash flow in 2018.
Centrica Group
Overall, adjusted gross margin and EBITDA were up compared to 2017, by 5% and 15% respectively, while adjusted operating profit was up 12%.
The adjusted net finance cost was down 21%, reflecting the impacts of a bond repurchase programme which completed in March, which led to an exceptional finance charge of £139m, and the maturity of a £400m bond in September.
However, the Group adjusted effective tax rate increased from 22% to 41%, with the 2017 rate including benefit from the resolution of past tax provisions and a one-off benefit from US tax reforms.
Group adjusted earnings of £631m was 9% lower than in 2017 and adjusted basic EPS was down 10% to 11.2p. The proposed 2018 final dividend is 8.4p, which would leave the full year dividend unchanged at 12.0p.
A net post-tax exceptional charge of £235m was recognised in 2018, compared to a charge of £476m in 2017. This included the net write-back of E&P assets, a provision for an onerous power procurement contract at Spalding and the impairment of UK power generation assets, guaranteed minimum pension equalisation past service cost and costs relating to restructuring and the repurchase of debt.
Total statutory gross profit was down 3% and statutory Group operating profit was up 105%. Statutory profit attributable to shareholders of £183m was down from £328m in 2017. This reflects the impact of the lower adjusted earnings and a net loss after taxation of £181m from the re-measurement of open commodity positions in 2018, compared to a net gain after taxation of £69m in 2017. These more than offset the impact of lower net exceptional charges. Basic EPS was 3.3p in 2018 compared to 5.9p in 2017.
Adjusted operating cash flow increased by 9% to £2,245m compared to 2017, within the Group’s £2.1bn-£2.3bn targeted range. This includes some benefit from the timing of E&P tax payments relating to 2018 profit, which are expected to be paid in 2019. After adjusting for commodity and foreign exchange movements, underlying adjusted operating cash flow fell by 0.2%. Statutory net cash flow from operating activities increased by 5% to £1,934m.
Group net debt was £2,656m at the end of 2018. This was slightly higher than at the start of the year and in the lower half of the Group’s targeted end-2018 range of £2.5-£3.0bn. From 1 January 2019, Centrica has adopted IFRS16, which will result in the Company recognising assets and lease obligations in respect of operating leases which did not previously meet the requirement for recognition on the balance sheet. The impact is to increase the Group’s 2019 opening net debt by approximately £420m to around £3.1bn.
STRATEGIC DIRECTION ALIGNED TO EXTERNAL TRENDS
Centrica is an energy and services company and our purpose is to provide energy and services to satisfy the changing needs of our customers. These changing needs arise from the three fundamental trends we identified as part of our strategic review in 2015, namely decentralisation, customer choice and power, and digitalisation.
Centrica’s focus for growth is therefore on the customer businesses in its Centrica Consumer and Centrica Business divisions. Customer needs are very similar globally and many are seeking more than simply energy supply. In response we have built new capabilities and propositions in both divisions and the simplified divisional structure enables Centrica to be more scalable, replicable and efficient. Centrica is now able to access customers, markets and geographies that we have never been exposed to before, bringing growth opportunities outside our traditional, more mature markets.
Our 2018-20 focus remains on performance delivery and financial discipline, as we look to demonstrate customer-led gross margin growth, drive further cost efficiency towards being “the most efficient price setter” in our markets consistent with our desired levels of service and brand positioning, utilise our global divisional structure to improve organisational effectiveness across the Group and work to secure the capabilities we will need for 2020 and beyond. We are seeing encouraging signs of demonstrating gross margin delivery in both Centrica Consumer and Centrica Business, with strong progress made on customer segmentation, customer lifetime value, enhanced customer-led proposition development and improved customer journeys.
MATERIAL NEW CAPABILITIES IN CENTRICA CONSUMER
Centrica Consumer transformation
Across the Consumer division we have made significant improvements in our customer-facing capability over the past three years. We are continuing to invest in the data science that underpins customer segmentation, to understand our customers better and create products and services that are tailored to their needs. Our enhanced capabilities are allowing us to optimise sales, marketing and retention spend towards the most valuable channels and customers.
We also continue to improve our customers digital experience, with customers who interact with us online having higher satisfaction levels. 60% of our customers are now signed up to interact with us through digital channels compared to 55% in 2017 while 50% of all UK transactions are now completed online compared to 45% at the end of 2017. NPS for digital customers in the UK is 5pts higher than those who manage their accounts offline. We are now also able to provide our services customers real time access to our engineers and technicians through our mobile app in the UK and North America.
We are increasingly utilising digital and data science to tailor offers and rewards for different customer segments, providing customers with more choice, deepening relationships with existing customers and broadening our appeal to new segments. This includes through personalised offers targeted at higher value customers. In the UK we now have 2m customers signed up to our British Gas Rewards programme and have more than 50 different offers available, with customer churn for our Rewards customers around half that of similar non-Rewards customers. Our Bord Gáis rewards programme in Ireland is also having positive effects on our customer satisfaction and retention.
We also continue to focus on increasing choice for our customers, with increased speed of product development and testing and increased bundling, while we are also expanding our offering to a wider range of customer segments through the utilisation of partnership channels.
Centrica Consumer stabilisation and growth potential
The rate of losses in account holdings in Centrica Consumer slowed, falling by 249,000, or less than 1%, in 2018 compared to a decline of 1,352,000 in 2017. A reduction in energy supply accounts was largely offset by growth in UK Home services, North America Home services and Connected Home. The rate of overall losses slowed significantly in H2 compared to H1, with Consumer account holdings falling by 23,000 over the second half.
UK energy supply account holdings fell by 742,000, including 97,000 prepayment accounts. The level of competitive losses largely reflects market switching trends, our efforts to move customers off the SVT, additional churn caused by two SVT tariff increases during the year and our focus on customer value. In North America, energy supply account holdings fell by 25,000 for the full year, but increased in the second half. Our more sophisticated use of data analytics in North America is allowing us to focus on acquiring and retaining the most valuable customer segments through cost effective channels and we delivered a significant increase in sales to higher usage customers at a lower cost to acquire.
We delivered customer growth in our non-energy supply activities. In the UK, our field force remains a unique asset, consistently delivering high levels of customer service with engineer NPS at +60 and is a key sales channel for Connected Home sales. UK services account holdings increased by 43,000 in 2018, the first full year of growth since 2010, as we attracted new customers with bundled energy and services propositions and developed further commercial and sales partnerships. We also saw an increase in the number of installation and on demand jobs, in part reflecting an acceleration of workload from Local Heroes, our digital platform enabled on-demand services offering.
With an assumption of more normalised weather, expected benefits from historic investment in growth, utilisation of more sophisticated pricing and expected further material cost efficiency delivery of at least £50m after inflation, we expect UK Home services adjusted operating profit to show significant improvement in 2019. North America Home services account holdings increased by 23,000, with further growth in Direct Energy paid protection plans, and further account growth and efficiencies are targeted in 2019.
We also saw further growth in products, hubs and subscriptions in Connected Home in 2018, with an acceleration in growth rates in H2. Having reached the 1m customer milestone in May, the cumulative number of customers increased by 444,000 over 2018 and stood at 1.34m at the end of the year. We also sold 1.2m connected home products in the year, meaning we have now sold nearly 3m products in total. This reflects the wider range of products now available on the Hive ecosystem, including our Hive View internal and external cameras, the Hive Hub 360 advanced hub and new lighting product ranges which were all launched in 2018.
We have also introduced subscription options for Hive Video Playback, Hive Link and water leak detection and commenced or announced a range of strategic partnerships, including with EE and Wave in the UK and with Eni gas e luce in Italy. The number of Connected Home subscriptions more than doubled during the year to 194,000.
UK energy supply default tariff cap
In July 2018, the UK Government passed a draft bill requiring Ofgem to impose a cap on all default energy tariffs including the Standard Variable Tariff (SVT). This is in addition to the safeguard tariff already in place for around 4m prepayment households and a further cap extension to another 1m vulnerable customers that took effect from April 2018. The cap took effect for all customers on default tariffs on 1 January 2019.
We have been very clear that we do not believe a price cap is a sustainable solution for the market, and is likely to have unintended consequences for customers and competition. Since the implementation of the cap, the differential between the highest and lowest SVT tariffs in the market has reduced from around £400 during periods of 2018 to around £150 early in 2019. In addition, the number of domestic energy suppliers in the UK has fallen by 12 since the start of 2018. In February 2019, Ofgem announced that the level of the cap for the period April 2019 to September 2019 would be increasing by £117 to £1,254.
With the cap now in place, we are focused on delivering a sustainable and attractive business in UK Home energy supply. We have already implemented mitigating actions in line with the ’14-point plan’ we announced in November 2017, a package of proposed actions and measures designed to reform the energy market and benefit customers. We have withdrawn the SVT for new customers, launched a range of new tariffs responding to customer needs and proactively offered our customers a fixed-price offer. As a result, the number of customers on the SVT has reduced from 5.0m at the start of 2017 to 2.9m by the end of 2018, in addition to around 600,000 customers on our new fixed-term default temporary tariff also covered by the price cap. We have continued to simplify bills, customer service levels have improved and we are on track to deliver targeted cost efficiencies of £20 per dual fuel energy supply customer by 2020.
As previously indicated, we expect the price cap to result in some negative near-term impact on earnings and cash flow in UK Home, particularly in 2019, before we have fully realised planned cost efficiencies. The level of the cap for the first quarter of 2019 was set at £68 below the British Gas SVT at the end of 2018.
However, Ofgem’s revision to the methodology for calculating supplier wholesale and hedging costs during the transitional period, and our inability to retrospectively mitigate this change, is expected to result in a one-off negative adjusted operating profit impact of around £70m in the initial period of the cap in the first quarter of 2019. In December, we announced we would be seeking judicial review of Ofgem’s decision relating only to the treatment of wholesale cost transitional arrangements and Ofgem’s decision not to investigate and correct its failure to enable the recovery of the wholesale energy costs that all suppliers incur. Based on the normal timelines for judicial reviews we would expect the process to be concluded in 6-12 months.
Whatever the outcome of the judicial review, we believe the actions we have taken over the past few years have positioned Centrica to serve our customers effectively and deliver a sustainable and profitable energy supply business under the temporary default tariff cap.
MATERIAL NEW CAPABILITIES IN CENTRICA BUSINESS
Centrica Business stabilisation and growth potential
UK Business delivered stable customer accounts over the year, with growth in the number of higher value SME customers. We have enhanced our range of offers through both direct and broker channels, including launching our online-only British Gas Lite proposition, using our customer segmentation and digital capabilities. We also drove an increase in the number of customers taking services offers and boiler installations, while we are actively focusing our Industrial & Commercial acquisition and retention activity on those customers who have a greater propensity to take our Distributed Energy & Power offers.
Our EM&T business also continues to build on its strong capability. We continue to expand our trading and route-to-market offerings, having signed a number of power purchase agreements for balancing and trading renewable capacity. We now have 13.8GW of route-to-market capacity under contract across Europe. In LNG, in February 2019 we signed a sales and purchase agreement to purchase gas from the Mozambique LNG project, in partnership with Tokyo Gas. This adds to Centrica’s LNG positions across regions, with our contract with Cheniere to export gas from the Sabine Pass facility in Louisiana due to start in September 2019.
Our DE&P business continues to grow, with all products now marketed under the Centrica Business Solutions brand globally. We have also launched our integrated solutions platform which gives customers access to our DE&P products and solutions in one place, incorporating the capabilities gained from the targeted acquisitions of Panoramic Power, ENER-G Cogen, Neas Energy and REstore. The REstore acquisition in 2017 has provided us with leading demand response capability which we have been able to utilise to launch a 27MW “Virtual Power Plant” at Terhills in Belgium, which pools an 18MW Tesla battery storage project with flexible load and generation from a series of industrial customers.
Our leading indicators in DE&P are demonstrating significant momentum, with order intake up 158% compared to 2017, and the secured order book 51% higher at the end of 2018 compared to the end of 2017. The amount of the 2018 closing secured order book relating to 2019 revenue was £183m, which compares to total 2018 gross revenue of £209m. The majority of new DE&P sales in 2018 were outside the UK, with a number of deals signed with existing North America Business customers, including with large housing corporations. North America and Rest of World formed 68% of the DE&P secured order book at the end of 2018 compared to 50% at the end of 2017.
Growth potential in North America Business
We retain a strong position and market share as the second largest business energy supply retailer by market share in North America. We are focused on driving improvements in profitability and returns in 2019 following the challenging trading conditions the business has faced over the past 18 months, which when combined with a structural improvement in retail power due to the timing effect of capacity charges is reflected in the higher forward order book in place for 2019. We also remain focused on delivering continued high levels of customer service while we continue to drive enhancements to our systems and processes, helping drive efficiencies and improve controls.
In the year we completed three small bolt-on acquisitions in line with our strategy, adding customers in our core regions of the US Northeast and Mid-Atlantic and in states in which we have less of a presence, specifically Indiana, Kentucky, Tennessee and Ohio. These transactions add around 150bcf and 6.5TWh respectively to our annualised customer gas and power consumption and strengthen our geographical footprint while diversifying risk across the portfolio. We also increased our market share organically in a number of regions, including Canada, Texas and California.
We have also implemented changes in our sales channel mix and products and propositions in response to customer demand, including launching our new Fixed Energy Plus offer, that gives high consuming customers access to real time energy usage and alerts them when system load is peaking allowing them to lower capacity costs by proactively reducing their consumption. We are also increasingly integrating value-added services propositions with our traditional energy supply and risk management offer, with our long-term customer relationships making North America the main focus region for DE&P growth.
EXPLORATION & PRODUCTION PORTFOLIO AND PERFORMANCE
E&P continues to play the role of providing cash flow diversity and balance sheet strength for the Group and the establishment of Spirit Energy in December 2017 has created a self-financing European E&P business.
Spirit Energy 2018 production performance was disappointing relative to our initial expectations and we currently expect 2019 production to be broadly in line with 2018 levels. Our focus remains on improving performance. Spirit Energy also made further progress on its development projects, with Oda proceeding to plan, a positive final investment decision being taken on the Nova field and exploration success at the Hades/Iris and Lille Prinsen prospects. As previously stated, Spirit Energy will continue to look at the potential for further opportunities to strengthen the business, which could include further consolidation with another party.
CSL’s Rough asset delivered strong production during the year, although volumes will naturally decline in 2019, in part reflecting its strong performance in 2018. We expect production from Rough in 2019 to be in the 6-8mmboe range. In August, the CSL-operated Easington processing plant was awarded a contract to process gas from the Tolmount field, securing its future until at least 2030.
In August, it was announced that Spirit Energy would invest in exploration and appraisal West of Shetland, after farming into 50% of Hurricane Energy’s Greater Warwick Area. Spirit Energy will fund a $180m campaign to drill three wells and prepare for an extended well test, with a rig secured to commence drilling in Q2 2019. The three wells will target the Lincoln discovery and the Warwick exploration prospect, which are estimated to hold 604mmboe 2C contingent resources and 935mmboe of prospective resources respectively. We expect to get initial indications of the results from the first well around the middle of the year.
CONTINUED STRONG COST EFFICIENCY PROGRESS
We delivered £248m of efficiency savings in 2018 as part of its Group-wide cost efficiency programme, with the Group incurring an exceptional pre-tax charge of £170m relating to associated restructuring costs. Cumulative annual savings delivered since 2015 are now £940m, with exceptional restructuring costs of £486m recognised over the past three years.
2018 total controllable costs are 10% lower than in 2015, with the Group having more than absorbed the effects of inflation, foreign exchange movements and additional operating cost investment in growth, which has helped to offset the effects market pressures have had on adjusted gross margin. We also delivered a like-for-like direct headcount reduction of 2,352 over the year.
The efficiencies in 2018 have been delivered predominantly in Centrica Consumer and our Group functions. In UK Home and North America Home we are driving further digitalisation of our customer operations activities in response to customer demand for self-service, and field force effectiveness through the integration of our field operations and associated back office and support activities. We have also delivered further procurement and supply chain savings, including from the simplification of our IT systems landscape, while the ongoing transformations of our HR and Finance functions are proceeding to plan.
We expect to deliver around £250m of additional efficiency programme savings in 2019, with further savings from the digitalisation of customer journeys, including focus on self-serve and automation, application of field technology, simplification of our core business processes, continued improvement in functional costs and procurement and supply chain savings. This will take total cumulative savings by the end of 2019 to around £1.2bn and including the roll-over into 2020 means we expect to have achieved our 2020 target of £1.25bn per annum a year early.
Cost efficiency will remain an area of ongoing focus for the Group, and we are targeting a further £500m of efficiencies beyond 2019, which would take the total annualised efficiencies since 2015 to £1.75bn, putting Centrica’s total cost base in a strong competitive position in line with our aim to be the “most efficient price setter” in our chosen markets.
PORTFOLIO SIMPLIFICATION
In February 2018 we announced our intention to divest our 20% interest in the entity which owns the UK operating nuclear fleet of power stations, subject to alignment with our partner and being sensitive to Government interests. Having commenced the first round of the sales process in H2 2018, this process is ongoing.
We continue to focus on high-grading and simplifying our portfolio. Reflecting this, we are targeting £500m of non-core divestments in 2019. We have already agreed the sale of our Clockwork home services portfolio and operations in North America for $300m (£230m), in line with our intention to drive channel and brand rationalisation across the Group. The remainder of the divestment programme will be delivered through the disposal of further non-core assets over the balance of year, including possible capital recycling in DE&P and E&P.
UK CAPACITY MARKET
On 15 November 2018, the General Court annulled the European Commission’s decision not to raise objections to the state aid scheme establishing an electricity capacity market in the UK. We are currently awaiting further updates from the Department for Business, Energy & Industrial Strategy in order to determine the full implications for the capacity contracts in place for our nuclear, battery and gas-fired generation assets, and for our UK energy supply businesses and the associated allowances for capacity market charges.
OUTLOOK AND SUMMARY
For 2019, a summary of our Group targets is provided below. These all remain subject to the usual variables of weather patterns, commodity prices, operational performance and regulatory change.
· Targeting adjusted operating cash flow of in the range £1.8bn-£2.0bn in 2019.
· £250m of efficiency savings in 2019.
· A like-for-like headcount reduction of 1,500-2,000 in 2019.
· Group capital investment expected to be around £1.0bn in 2019.
· £500m of non-core divestments in 2019.
· Net debt expected to be in a £3.0bn-£3.5bn range in 2019, including the impact of IFRS 16 adoption.
2019 adjusted operating cash flow will be impacted by a number of factors, including the UK energy supply default tariff cap, continued low E&P and Nuclear volumes and cash tax phasing. As a result, the midpoint of our adjusted operating cash flow guidance is around £350m lower than the 2018 result, with around £100m of this reduction also expected to impact 2019 adjusted earnings. However, our net debt levels are underpinned and we are taking further actions in 2019 to improve underlying performance and strengthen 2020, including driving further cost efficiencies, tight control on capital expenditure and £500m of non-core divestments. This continued focus on performance delivery and financial discipline will enable us to offset some of the near-term challenges facing the Group, while maintaining a strong balance sheet.
Our strategic direction remains aligned to external trends, and we have developed material new capabilities in both Centrica Consumer and Centrica Business, exposing Centrica to an expanding opportunity-set. We are seeing encouraging indications of stabilisation and growth potential. We also continue to re-focus and simplify the portfolio both through the ongoing nuclear disposal process and the non-core divestments. Our focus remains on performance delivery and financial discipline, as we continue to satisfy the changing needs of our customers.
