Centrica Looks Solid After British Gas Price Hike

Morningstar analysts believe the energy company's strong balance sheet and diverse earnings can support its attractive dividend

Charles Fishman 23 October, 2013 | 2:16PM
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Centrica (CNA) has achieved steady earnings and dividend growth despite reduced retail gas and power demand and a large tax increase on North Sea gas production. The solid financial performance during tough macroeconomic times was due to its strategy of hedging roughly 50% of its retail energy sales with its own assets. However, owing to the declining production in the aging Morecambe gas fields,  Centrica has made several acquisitions of gas properties and increased its exploration to maintain this effective hedge level.

The key to continued earnings and dividend growth will be the amount of oil and gas Centrica produces from these acquisitions and the success of its exploration programs. Both create risk for investors. Still, we believe the company's strong balance sheet and diverse earnings can support its attractive dividend.

Centrica is also betting on the success of its retail strategy in the U.S. The mid-2013 acquisition of Hess’ energy marketing business makes Centrica the largest business gas supplier on the East Coast and the second-largest business power supplier in the U.S. Whether this integration along the retail energy chain can create a moat remains to be seen.

We are reiterating our 380p per share fair value estimate. Although U.K. forward power prices have declined since our last update, natural gas prices have strengthened. This indicates that Centrica's hedge strategy is working. In addition, our fair value estimate benefited from time-value appreciation.

We expect mostly flat operating profit growth from British Gas during the next five years. The increase in natural gas prices and continued strong competition in retail power will likely result in a challenging operating environment. We also expect the U.K. natural gas storage market to be weak in 2014 and then assume a modest recovery through 2017. Centrica announced earlier this year it had sold forward its entire storage capacity for the 2013-14 season at an average price more than 30% lower than 2012-13. The weakness reflects the lower summer/winter price differentials, which are difficult to forecast long-term.

Although operating profit from Centrica Energy has more than doubled since 2009, we estimate this segment will earn approximately £1.5 billion in 2017, 20% higher than 2012. Strong growth from oil and gas production and a modest recovery in natural gas power plant spark spreads and realized power prices for the nuclear plants should drive this improvement. Expansion of Centrica's renewable energy portfolio, due in large part to the completion of the Lincs offshore wind farm, should also add to earnings growth.

We also expect Direct Energy to increase operating profits to £465 million by 2017, a 40% increase over 2012. Although the majority of this improvement is due to acquisitions, we also assume some organic growth.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Centrica PLC69.75 GBX1.02Rating

About Author

Charles Fishman  Morningstar Equity Analyst, Equity and Credit Analysis