Concerns Sparked for Energy Giant

James Penn
June 3, 2019

A month ago this column looked at one of several blue chip messes floating around the lower echelons of the FTSE100 index.

Then we had Sainsbury’s and its blocked merge with Asda but I thought this week might be an opportune time to look at another, in this case Centrica, the energy utility.

Centrica currently has a dividend yield of 12.94%. It comes top in the FTSE100 list of payers, and almost top of the FTSE All Share index, once one adjusts for companies that have cut pay-outs this year.

It screams value – using metrics like low Price to Earnings ratio or low Price to Book – but has been anything but such for the past six years with another lurch downwards at the start of the 2019.

The stock market no longer believes in that dividend yield – despite management still being committed to it. Given that a number of other high yielders, with seemingly adequate propensities to pay, have caved on their dividend commitments in the past month, investors are probably right to be sceptical.

Vodafone, for instance, cut its payout by 40% a few weeks ago. More recently, Royal Mail Group cut its dividend for next year, whilst maintaining the final pay-out for the last financial year at 15p.

Several blue chip dividends are being slashed with machetes as companies transition to new business models or pay for the costs of additional investment that didn’t appear on the horizon until recently.

So will Centrica be the next to follow? Centrica is investing fairly heavily and is suffering as its once profitable business model (supplying gas and electricity to UK consumers) comes under threat from new competition.

Centrica has had a poor 18 months with three profit warnings and shares are down nearly 75% from highs of £4 in 2013. This peak came just ahead of the rhetoric on ‘rip off’ gas bills at the 2015 election – led by Labour but with the Tories left to legislate for a capped SVT at the start of 2019.

Competition has increased meaningfully in retail gas and electricity supply, with price comparison websites allowing new entrants to gain share in the energy supply market (there are now over 80 retail energy suppliers). The competition took its time but has now kicked in with a vengeance – combined share of the ‘Big Six’ retail suppliers is now under 70%.

In 2018 Centrica’s UK retail profits fell to £670m from £820m in 2017, a drop of 18%.  In the first four months of 2019 Centrica offset this with £58m of cuts, with £250m planned for the full year. If achieved this will make a big difference.

Another problem for Centrica arose following an EU investigation into the capacity market (where power plants get paid excess rates for producing power at times of excess demand). As a result the investigation, the market was suspended leading to reduced profits for energy supplier.

Centrica has been trying to turn itself into a ‘consumer facing’ business, as opposed to the asset-intensive energy utility that it used to be. It has some interesting new businesses in Connected Home and DE&P (Distributed Energy & Power) which could provide growth in future years. Each is expected by management to make sales of £1bn by 2023, though both are loss making at present.

An AGM update on 13th May was better than expected, given that the warm weather and lower gas prices in the early part of the year as well as various nuclear outages might have been expected to lead to a downgrade.

British Gas lost 234,000 customers since the start of 2019, and though that represents churn of 6% annualised this is merely a continuation of recent trends.

Centrica is slightly unique in that, unlike National Grid and SSE, it doesn’t own regulated networks which have been more popular with investors recently. It also has more exposure than most utilities to volumes and commodity prices (although much of this is hedged).

What’s more, Centrica doesn’t have much renewable exposure which has also counted against it.

The shares look cheap on a price to free cash flow of 7.15, assuming 13p of FCF in 2019.

The shareholder base suggests some significant changes in the past month, with investors like Blackrock and Legal & General taking positions in the stock, while long time holders like Invesco have reduced theirs.

The news on the dividend is likely on 30th July. Let’s hope it’s good.

Disclaimer: The views thoughts and opinions expressed within this article are those of the author, and not those of any company within the Capital International Group (CIG) and as such are neither given nor endorsed by CIG. Information in this article does not constitute investment advice or an offer or an invitation by or on behalf of any company within the Capital International Group of companies to buy or sell any product or security.

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