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How Centrica PLC Makes Money

We all have a broad idea of what the companies in our portfolios do. But how much do you really know about their products and their markets, or how much each of their activities contributes to the bottom line? Understanding how a company makes its money can help you decide whether it’s a good investment.

Today I’m examining just what Centrica (LSE: CNA) (NASDAQOTH: CPYYY.US) does. Best known as owner of British Gas, Centrica has significant upstream and US businesses, and describes itself as an ‘integrated energy’ company.  Here’s how 2012’s operating profit was made up:

   
Upstream 48%
Downstream UK (British Gas) 40%
Downstream US (Direct Energy) 12%
Total 100%

British Gas

British Gas supplies gas and electricity to 25m consumers and employs 30,000 of Centrica’s 40,000 workers. It has an astonishing 40% share of the gas market and 25% of electricity.

The business isn’t economically regulated like true monopoly utilities are, but there are onerous licensing conditions that constrain profitability. Currently suppliers are being forced to simplify the tariffs they offer. Nevertheless, the utility-like nature of British Gas’s business adds a big slug of dependable profits to Centrica’s bottom-line.

The UK industry is mature and there’s little growth, so competitors poach each other’s customers based on price (mainly) and service: there’s a concept of customer ‘churn’ more familiar in the telecoms industry. Extra profit opportunities come from services such as boiler repair and installation. Surprisingly, these services make up nearly a third of British Gas’s profits.

Upstream

Centrica’s upstream activities supply energy to the downstream segment, hedging wholesale energy price fluctuations. The company is responding to changes in energy mix, estimating that by 2020 three-quarters of the UK’s gas will be imported, and shale will provide a third of US gas. It has major oil and gas interests in the North Sea along with Morecambe Bay and Trinidad and Tobago. It has bought upstream North American assets and secured long-term gas supply agreements.

In generation, Centrica’s gas-fired power stations are loss-making and further investment depends on Government energy policy. Centrica operates off-shore wind farms, and has a 20% interest in existing nuclear plant but has pulled out of new-build because of uncertainties over returns. It also operates 70% of the UK’s gas storage capacity. Generation and storage contribute about 20% of the upstream profits.

North America

Centrica aims to double the profitability of its North American downstream operations in the next three years, so the 12% contribution to total profit will rise. A recent £0.5bn acquisition is a significant step. The company supplies residential consumers in North East US and Texas, and business customers nationwide. The competitive market is less sophisticated than the UK’s, so Centrica is importing skills from British Gas to grow market share.

Yield

With half its profits coming from upstream and ten-years’ worth of reserves, Centrica is as much an oil and gas company as a utility, but that hasn’t hampered the reliability of its attractive and consistently-rising dividend.

If you are looking for reliable dividend-payers, I recommend you have a look at the Motley Fool’s Top Income Stock. It’s yielding over 5% and intends to increase the payout at least in line with inflation. With the Bank of England holding down interest rates for the next couple of years, that’s a great yield to lock in! Just click here to read the Motley Fool’s report.

> Tony owns shares in Centrica