The utility company that thought it was an oil and gas production company: a cautionary tale of too much ambition and enterprise

5 mins. to read
The utility company that thought it was an oil and gas production company: a cautionary tale of too much ambition and enterprise

Centrica (CNA): at 270p last seen.

The technical chart position looks inviting. Clearly something has to be done to put Centrica (CNA) back on the straight and narrow. A rights issue seems less likely to me than the better option of flogging off those expensive assets, on which it will be near impossible to make profits in the near and medium term. If that happens, it should put the company back in good odour with the market, enabling institutions to average down the historic book cost of earlier investments, with new share purchases.

For your down to earth ‘plain vanilla’ investor like me, it is handy to have an abbreviated notion of what the company is, in a cluttered head. I like to know where it stands and thus, where I stand.

My rough and ready notion of an ideal utility is a company that operates in markets of pretty steady demand – give or take a warm winter or two – and that operates on low net profit margins and generally, therefore, offers an above average dividend yield to help us pay our utility bills in winter. Utilities are generally perceived as not very cyclical and therefore amongst the less risky of investments. If there is an above average dividend yield and that dividend looks relatively safe, that puts a floor under the share price.

Naturally, none of this is wholly true but such industrial and commercial generalised profiles help when you are looking for a piece to fit into the jigsaw of a portfolio of shares before looking at it closely to see if it actually fits the gap.

To most of us I presume, Centrica is domesticity and ‘British Gas’; blue and white vans, domestic boilers and quarterly bills. But that is deceptive. Centrica is one of those companies that set out to conquer the world by turning itself into an energy exploration and production company, operating on the high cost frontier of expensive energy, at a time when oil and gas prices were extraordinarily high.

It evidently regarded its dull but reliable energy supply business in the UK as a useful cash cow for such expansion. In the six years up to 2013, it made six acquisitions of oil and gas production companies for a total investment of a reported £5.4 billion, from the North Sea to Trinidad and Canada. It was a big money, high stakes game which came unstuck when that same high cost of oil and gas – aided by advanced fracking technology – produced in response more supply than the world demanded; particularly when China was moving away from an ‘infrastructure’ building led growth model towards one of more domestic consumption. For Centrica, balance sheet debt has risen every year since 2010.

Last year to December 31st 2014, the total debt to equity gearing ratio was a massive 252%. A more than troublesome debt leverage figure when top line prices were put under monumental pressure, like that last year.

The Centrica share price peaked somewhere just above 400p in late 2013. It then tobogganed down to 234p in March from where it started to head north again. Last seen, the share price was 270p having, arguably, just about broken out of the big downtrend. Have a look! It is slight and recent, and thus tentative as well.

Last year, although sales revenue was more than 10% higher year on year, there was a reported statutory pre-tax loss of  £1.4 billion where the previous year there had been a pre tax profit of just under £1.65 billion – thanks in part to an unusual profit and loss account expense of a massive £2.7 billion. Will that, or anything like it, be repeated again? In the balance sheet, net assets fell £2.45 billion to £2.7 billion. Clearly, a lot of damage was carried last year affording an implication that the accounts were keeping up with events. Politically, with an energy related general election in Centrica’s UK home retail market, 2014 was a doubly good year for showing a big net loss.

Interestingly, the consensus market estimates are of only a 6% decline in earnings for this year (in contrast to the comparable 28% fall in earnings last year) followed by an estimated 3% rise in earnings next year. They also estimate a 4.4% annual dividend yield for this year and an estimated 4.5% annual dividend yield next year, after an estimated small increase in the dividend payout.

The company is undoubtedly over-geared with debt and therefore undercapitalised. Will the management choose to seek a rights issue to put that right, or conversely, sell off the assets it so badly bought at those undoubtedly un-repeatable high prices of the last few years?

It is my instinct that it will choose the latter rather than the former, given the embarrassment of a totally misread strategy before. When institutions invest by way of rights, they logically do so on the basis that the management have the judgement to make things work well. That is in some doubt now. Moreover, it looks to me as though no one is expecting a big rise in oil and gas prices, or related assets, any time in the near term. So selling energy production assets and getting back to the energy supply business looks to be the most acceptable solution for Centrica at this stage.

If it took those related losses on those assets through the profit and loss account last year – I put that as a question not a statement – then the management may have significantly cleared the ground for a sale of those assets, to diminish the impact on the profit and loss account this year or next. Hence, the much less dramatic changes in consensus earnings estimated this year and next.

I also surmise, reasonably I hope, that Centrica’s greatest usefulness lies in being an above average dividend payer not an above average growth stock. I think the market would be happiest if the company sold off its energy production assets without too much of a loss, and maintained and or slightly increased the dividend payout. That view seems to chime with the market consensus estimates. I have no means of foreseeing the future but that is the feeling in my bones and my interpretation of unfolding events. The company’s CEO is expected to lay out his plans to the market soon; until then, it is a matter of speculative judgement.

The Markit survey of short selling positions gives Centrica a low rating for that. As said earlier, the chart seems to possibly indicate a tentative breakout, in an upwards direction. I seen no reason to sell now and see some logical reasons for making the shares a buy.

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