Jeremy Warner's Outlook: Centrica abandons quest to defend its margins

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With Centrica's share price back to within a whisker of its all-time high, it was bound to be vulnerable to even the remotest hint of disappointment, and so it has proved.

With Centrica's share price back to within a whisker of its all-time high, it was bound to be vulnerable to even the remotest hint of disappointment, and so it has proved. In a trading update yesterday, Sir Roy Gardner, the chief executive, insisted that profits were still on track to meet market expectations this year, but it counted for nought against the admission that margins in the core gas supply business were falling below target.

Even so, the share price reaction - down nearly 10 per cent at one stage - seems harsh in view of the fact that the business model is actually working just as it was supposed to, with the increased cost of supply now neatly balanced out by the increased prices Centrica gets for its upstream activities.

As always in these situations, the worry is that the present pressure on margins is only the start of a run of bad news after a prolonged period in which Centrica appeared to be able to do no wrong. Even when Centrica sharply raised its domestic gas and electricity prices last August, it was generally greeted in the City as a perfectly sensible way of defending profits against the cost of soaring energy prices.

Centrica is still the dominant supplier of gas in the UK, with more than half the domestic market, and it is also one of the biggest suppliers of electricity. The cost to the bottom line of leaving prices where they were was always going to be a whole lot more than the inevitable loss of market share that would result from being price uncompetitive. However, I'm not sure even Centrica fully appreciated quite how many customers the price rises would cost. The net loss of energy customers in the second half to date has been a stomach-churning 630,000, bringing to nearly a million the number lost for the year as a whole.

Belatedly, Centrica has realised that if it carries on like this, it won't be long before there's no business left to defend, or as the statement puts it: "The group has decided to balance the level of margin in the short term with the need to maintain a competitive position in order to preserve value in the longer term." What that means is that Centrica will be taking some of the anticipated increase in the costs of energy supply on the chin next year, rather than attempting to pass it on to customers. Some of the expense of doing this can be offset through a further round of cost cuts, but probably not all.

Still, what Centrica loses on its domestic supply business by trying to remain price competitive, it gains on its upstream activities. The hedging mechanism so painstakingly assembled is delivering just as intended. Regrettably for Sir Roy, this message rather got lost in the panic over margins. Unwisely in my view, the group insisted that a net operating margin of 8 per cent was still achievable for the gas supply business, thereby creating another target to miss. When will managements learn that it never pays to nail yourself to the mast in this way?

Mandatory pensions

You may have thought you'd heard the last of Sir Peter Davis after his ignominious exit from J Sainsbury with a £4m bag of swag across his shoulder. But Sir Peter is nothing if not thick skinned and next week he pops up again as chairman of The Employer Task Force on Pensions with a new report which recommends that employers be forced to contribute to their employees' pensions.

This is a subject Sir Peter personally knows quite a lot about. For his four years of mismanagement at Sainsbury, he walks away with an annual pension of £111,000 on top of a near £4m pay-off. He's also entitled to a final-salary pension from both Reed and Prudential, where he was once chief executive. In making his recommendation, he's presumably just trying to ensure that everyone else shares in his good fortune.

Pensions are a source of growing concern to all of us, but Sir Peter's central idea is a lot of wrong-headed, utopian nonsense. There is no more reason why employers should be forced to provide their employees with pensions than company cars, health insurance or a basic minimum of £50,000 a year.

At root, pensions are only a form of deferred pay. Employers that pay the best pensions can hope to attract a correspondingly superior workforce, but that shouldn't obviate those who provide nothing at all from creating employment. It is not at all clear that those who "duck" their pension responsibilities are gaining an "unfair" competitive advantage over those who don't. Actually all they are doing is paying less, which is rather the way the market is meant to work, or have I missed something here?

Business has already been loaded up by the Government with quite enough social and employment obligations. To impose compulsion in pension provision would only be another form of tax on employment. That's not to say that society doesn't need and deserve better pension provision, but if that's what public policy desires, then it should be imposed through the tax system, not on employers.

Of course, we all know why that's not going to happen. From Downing Street's point of view, it is much better to characterise the business community as the guilty party in the failure of our pensions system than the Government. Imposing an extra cost on business is likely to prove politically less damaging than admitting that taxes need to rise to pay for decent pensions provision.

There is only one worthwhile argument for compelling people to save for their old age. That they won't do so voluntarily is a form of market failure which means ultimately they will have to fall back on state benefit to compensate for their lack of thrift. Yet for the low, or even moderately well paid, the amounts likely to be saved, even with a compulsory employers' contribution, are too small to make a significant difference. For many small enterprises, compulsory pension provision would be unaffordable. Much better that the state provides a decent bare minimum, leaving the individual, properly incentivised, to look after the rest.

Business is about focusing on the bottom line. The social bit can reasonably be left to governments to worry about. To expect companies to do more just confuses the picture. The most surprising thing is that Sir Peter, a one-time captain of industry, doesn't seem to have recognised any of these arguments. No wonder he made such a hash out of Sainsbury's.

Stamp prices

Having failed to achieve all but one of its 15 quality of service targets in the first half of this year, Royal Mail proposes to increase the cost of a first-class stamp by an inflation-busting 7 per cent to 30p. Bizarrely, Adam Crozier, the chief executive, says he needs the price rise to prepare for the opening up of the UK postal market to full competition in 2006. Competition usually means lower prices, yet in the Alice in Wonderland occupied by Royal Mail, it seems to mean the opposite.

According to Mr Crozier, the Post Office loses 5p on every first-class delivery, and 9p on second class. Those losses are paid for largely by bulk business mail, where the biggest impact of deregulation will be felt. In order to pay for lower prices for business post, be must therefore raise prices for domestic post.

Personally I cannot see how it is possible to separate the two, since the great bulk of business post couldn't be delivered unless serviced by the network of posties Royal Mail must maintain for the postal system in general. To claim that business post is profitable but "ordinary" domestic post isn't is just accounting mumbo jumbo.

Actually, the great bulk of this price increase will go to servicing the posties' pension scheme, where a giant deficit has inexplicably opened up since the last revaluation three years ago, which showed a surplus. And Allan Leighton is said to have volunteered to have his contract as chairman extended.

jeremy.warner@independent.co.uk

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