Should I Buy Centrica?

Published in Company Comment on 23 November 2012

Harvey Jones sizes up Centrica (LSE: CNA).

It's time to go shopping for shares again, but where to start? There are loads of great stocks to choose from, and I've got my wallet out. So here's the question I'm asking right now. Should I buy Centrica (LSE: CNA)?

Winter warmer

I detect a chill in the air, but investors in Centrica won't be moaning about the weather. A cold winter should boost revenues and profits for the energy supplier, which owns British Gas. That will be cold comfort for anybody opening their gas and electricity bills, but it should give investors a warm glow. So is now the right time to buy?

Life's a gas

UK utilities are about as popular as the big banks these days, thanks to an unfortunate habit of announcing large price hikes and profit rises at roughly the same time. Earlier this month, SSE (LSE: SSE) announced a 38% increase in profits to nearly £400 million one month after its 9% gas and electricity price hike. Centrica's 6% price rise in mid-November kicked in the day after British Gas announced an expected £1.4 billion profit in 2012. It blamed the price spike on the cost of upgrading the UK's gas and electricity grids, chasing carbon-reduction targets and rising wholesale gas prices. The public were too angry to listen but investors should pay attention, because higher wholesale prices squeeze margins.

Shale and hearty

Centrica's recent third-quarter update kept the market happy, with year-on-year earnings growing in line with market expectations. Average UK residential gas consumption rose 9% in the first 10 months of 2012, as this year was colder than the last, but it was offset by a 1% drop in electricity consumption. Centrica is also expecting to increase its upstream gas production by nearly 20% this year and up to 15% in 2013, after completing three acquisitions in the North Sea, including Seven Seas and Ensign.

Centrica is rumoured to be pulling out of building a new nuclear power station at Hinkley Point, Somerset, a partnership with French energy giant EDF. If confirmed, that looks like a good decision for shareholders, given endless government dithering over energy policy, which makes long-term investment almost impossible. Centrica should find easier pickings in the US, where it plans to buy cheap shale gas for the UK market.

Hit for six

My big concern about this stock is that politicians and regulators will come under growing pressure to stick the boot into utility companies, to satisfy an overheated public. Any plans to limit what energy companies can charge could deliver a shock to the share price. Wisely, Centrica is looking to cut costs by around £500 million a year, giving it some cushion. Another uncertainty is that the big six power players, British Gas, EDF, E.on, Npower, Scottish Power and SSE, have been accused of fixing prices in the £300 billion wholesale gas market. They reject the allegations, but it all adds to the regulatory heat.

Sizzle or fizzle?

Utilities may be a defensive play, but Centrica isn't immune to a slowing economy. Cash-strapped households are less likely to spend money installing central heating, for example. They put on a jumper rather than turning up the thermostat. On a forecast price-to earnings ratio of 12 times earnings for December 2012, this isn't the cheapest FTSE 100 stock either. On the plus side, there's a 5% yield and a progressive management dividend policy, with the half-year dividend recently increased by 8% to 4.62p per share. I'd call it a sparky hold, rather than a sizzling buy.

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> Harvey doesn't own any shares mentioned in this article.

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ANuvver 23 Nov 2012 , 1:02pm

Fair piece, and good on you for highlighting the "political football" nature of the sector.

Utilities have always been subject to regulatory risk, but I would suspect that in a climate of austerity, that risk is higher than many appreciate. When margins are at the mercy of politicians desperate to appeal to a struggling populace who are broadly resentful of corporate profits...

Of course, one of MF's boyfriends recently liquidated his entire NG holding because he didn't the sound of Ofgem's proposals for funding the chronically needed massive infrastructure upgrade. Click _here_ to find out which boyfriend. It's free!

A "picks and shovels" approach to investing in the impending infrastructure overhaul is a theme I'm pondering much of late.

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