View from City Road: Uncomfortable time for Gas investors

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The Independent Online
British Gas's third-quarter figures make predictably depressing reading. While the Department of Trade and Industry consults all and sundry about the MMC's demand for it to be broken up, British Gas is hardly going to be radiating happiness and prosperity.

An increase in losses in the seasonally weak third quarter from pounds 190m to a worse-than-expected pounds 225m, dragging the nine-month net income total down from pounds 447m to pounds 409m, is not encouraging, nor is it intended to be.

The dual squeeze from the RPI minus five formula on domestic tariffs and compulsory loss of market share in contract markets is having its desired effect from a regulatory point of view.

As a result, operating losses in UK gas supply worsened by pounds 10m to pounds 227m in the third quarter despite a 10 per cent rise in the volume of gas sales.

As if this were not enough, British Gas surprised investors with a pounds 50m loss in exploration and production - the supposed jewel in the company's crown from mid- decade - thanks to write-offs and higher depreciation on new fields.

To rub salt into the wound, the third-quarter loss is understated since it includes a pounds 45m benefit from improved weather and the use of pounds 25m worth of restructuring provisions.

Investors in British Gas face an uncomfortable future, particularly where dividend growth is concerned. Even if the Government decides, on the grounds of costs and the initial rise in prices, against a break-up of the company into separate trading and pipeline businesses, it will surely want to stimulate competition even more quickly than the MMC suggested.

That does not bode well for earnings growth in the interlude before, or even after, exploration and production begin to chip in. Before an exceptional charge for restructuring - which, with 20,000 jobs at stake, could top pounds 300m - profits of just under pounds 1bn this year would cover a 14.5p dividend only 1.5 times, against British Gas's target of twice cover.

Scope for dividend growth above the rate of inflation looks limited. Despite an attractive 5.5 per cent yield British Gas shares could well be left behind as industrial earnings recover.

Among other utilities, BT, which has delivered real dividend growth of 4.5 per cent a year since privatisation, offers much the same yield and looks better value.