Share tips: a solid income-generating energy giant

published 9 March 2012

Centrica (LSE: CNA), rated a STRONGBUY by Standard and Poor's

If you want a solid income generator, look no further than British energy giant Centrica. Despite being hit last year by a tax hike on North Sea oil assets and a mild winter (which led to a 21% drop in household gas demand), the group still lifted its dividend by 8% to 15.5p.

Centrica's strong defensive qualities are down to two features. Its upstream operations (42% of profits) are nicely balanced by its downstream activities. So £1bn in annual profits from oil and gas production was matched by figures from the power distribution arm (eg, British Gas). Its substantial hydrocarbon deposits are located in British and Norwegian coastal waters.

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That means that, although it's exposed to volatile oil and gas prices, it isn't dependent on geopolitics in less stable regions. Indeed, after recent acquisitions from Statoil (£1bn) and Total (£246m), Centrica now owns 615 million barrels of oil equivalent (boe) of proven and probable (2P) reserves. That's more than eight years of output.

It's also tying up long-term supplies via a three-year liquified natural gas (LNG) agreement with Qatar. The aim is to expand production by 50% to 75 million boe per day by 2014, up from 50 million today. That reinforces Centrica's position as Britain's number-one gas producer.

Elsewhere, the board is driving down costs and implementing new state-of-the-art client monitoring systems (eg, 400,000 smart meters) that reduce customer servicing costs. Centrica's chief executive, Sam Laidlaw, is spearheading the £500m initiative, which entails a further 2,300 staff being laid off. The group owns a 20% stake in British Energy and aims to triple its offshore wind capacity by 2016. This gives it the right mix of assets as the world moves to lower-carbon fuels over the coming decades.

The City is forecasting 2012 sales and earnings per share (EPS) of £23.3bn and 27.6p respectively. That puts the shares on a price/earnings (p/e) ratio of 11, with a 5% yield (1.7 times covered). I rate the stock on a 14-times earnings multiple. Adjusted for net debt of £3.4bn (equivalent to 1.1 times earnings before interest, tax, depreciation and amortisation - EBITDA), that delivers an intrinsic worth of 385p a share.

The stock has been hit by technical selling from Citigroup, which is trying to offload around 200 million shares it bought from Petronas of Malaysia in early February. Another problem is the regulator Ofgem's review of the domestic power market. Centrica has promised to simplify its tariffs and provide customers with a complete breakdown of charges, ahead of the regulator's report towards the end of this month. Standard & Poor's has a target price of 423p and the next trading statement is due out on 11 May.

Rating: BUY at 305p

Paul Hill writes a weekly share-tipping newsletter, Precision Guided Investments. See www.moneyweek.com/PGI .

Paul gained a degree in electrical engineering and went on to qualify as a chartered management accountant. He has extensive corporate finance and investment experience and is a member of the Securities Institute.

Over the past 16 years Paul has held top-level financial management and M&A roles for blue-chip companies such as O2, GKN and Unilever. He is now director of his own capital investment and consultancy firm, PMH Capital Limited.

Paul is an expert at analysing companies in new, fast-growing markets, and is an extremely shrewd stock-picker.