Centrica’s optimistic outlook does not make up for its growing challenges
Centrica, Britain's biggest energy supplier and owner of British Gas, looks to be on track to report a bumper performance for 2022, says Rupert Hargreaves. So should you buy Centrica shares?
Since the start of 2021, 30 energy suppliers have gone out of business, affecting 4.5 million customers and raking up costs for households. The estimated cost of these failures could be as much as £2.4bn, most of which will be passed on to consumers.
The energy market crisis has ripped through the industry, causing havoc with even the most established suppliers such as British Gas owner Centrica (LSE: CNA). However, there is a silver lining in the crisis for the FTSE 250 company.
British Gas’s share of the retail gas market dropped from almost 44% to 28% between 2011 and 2021, and its share of the electricity market fell from 24% to 19% as the number of suppliers surged from 14 to 70.
As suppliers have failed, Centrica has stepped up. It has added around three quarters of a million new customers from defunct suppliers, and further deals could be on the cards.
The FTSE 250 group could benefit from the situation
The crisis could help Centrica’s reputation. Not only has the company survived (and is taking on new customers) it is also protecting client funds in segregated accounts, spending £50m on improving its customer service and funding the British Gas Energy Support Fund. The fund provides grants of up to £750 to help customers pay their energy bills. While this spending only scratches the surface of the energy crisis, it helps Centrica and British Gas stand out in a crowded market.
Despite the turmoil of 2021, Centrica ended 2021 in one of the strongest positions it has found itself in this decade. Pesky competitors have been cleared from the market, regulators are looking to reform the market’s pricing constraints, and the organisation has the capital to pursue growth opportunities. Following the sale of the group’s US energy business, it ended the year with a net cash position of £680m.
It looks as if the business is now on track to report a bumper performance for 2022.
In its latest trading update, Centrica revealed that operational performance in the first four months of the year was “strong.” It also said that volumes from its nuclear and gas production assets in the UK have been robust, and it has secured additional resources to strengthen the UK and Europe’s energy future.
While management is warning that “significant uncertainties” remain over Centrica’s performance for the rest of the year, it is confident enough to upgrade profit projections. It now expects earnings to be at the top of analysts’expectations for the year, suggesting it is on track to earn in the region of 10.8p per share for 2022.
Centrica’s supply business gives it an edge in a competitive market. Its nuclear business gives it an important source of zero-carbon electricity and it has plans to build gas-fired peaking plants, solar and battery assets, as part of its ambition to increase renewable energy production and supply.
And Centrica has the largest services field force in the UK, with around 7,000 engineers. This means the firm can offer to install new technologies such as heat pumps and electric-vehicle charging points for customers; smaller suppliers don’t have that ability. Centrica wants to be installing 100,000 electric-vehicle charging points and 20,000 heat pumps a year by 2025.
Even taking these tailwinds into account, the stock is far from being a screaming buy in my book.
It’s going to be hard for Centrica to become a great business
Centrica has failed to consistently earn a profit and generate value for shareholders. Despite the belief that utilities tend to be relatively stable and defensive investments, the FTSE 250 stock has returned -2.4% a year for the past 15 years, (including dividends) underperforming the wider market by 7.4% a year.
Its main problem is razor-thin profit margins. Since 2011 it has earned an average net profit margin of 1.47%. With the company earning just 1.47p for every £1 of revenue there’s no room for error.
It is incredibly unlikely this is going to change. Ofgem is not going to let the market return to its pre-2011 level of consolidation. Competition is here to stay, and in a commoditised market like energy, where all suppliers offer the same product and can only compete on price, it seems unlikely British Gas will ever be able to earn fatter margins from its customers.
Developing for a changing environment
Based on growth projections for 2022, the stock is selling at a forward price/earnings (p/e) ratio of 6.9. That looks cheap, but as the company itself has admitted, uncertainty prevails. Saying it will hit this target is one thing, actually doing so in an increasingly uncertain world is another thing altogether.
Even though Centrica appears cheap, I’m not rushing to add the stock to my portfolio. Growing uncertainty and the firm’s razor-thin profit margins suggest it will continue to struggle, despite its competitive advantages. A prospective dividend yield of 4% does not do much else to sweeten the appeal.
While Centrica might surprise to the upside over the next couple of years, I’d rather own a business that has a stronger record of growth and quality.