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This P/E Suggests Centrica PLC Is A Hold

The FTSE 100 has risen by more than 60% since it hit rock bottom in 2009, and bargains are getting harder to find, despite the market’s recent losses.

I’m on the hunt for companies that still look cheap, based on their long-term earnings potential. To help me hunt down these bargains, I’m using a special version of the price to earnings ratio called the PE10, which is one of my favourite tools for value investing.

The PE10 compares the current share price with average earnings per share for the last 10 years. This lets you see whether a company looks cheap compared to its long-term earnings.

Today, I’m going to take a look at the PE10 of integrated energy company Centrica (LSE: CNA) (NASDAQOTH: CPYYY.US).

Is Centrica a buy?

Centrica’s near-50/50 focus on being an integrated energy firm makes it slightly different to most UK utilities and energy firms. This divide makes it harder to decide how to value Centrica. Should it be treated as an energy firm, as a utility, or as both?

Let’s take a closer look at the firm’s current valuation:

  Trailing P/E PE10
Centrica 14.7 18.9

Institutional investors seem to think that Centrica should be valued as a utility. Its trailing and forward P/E ratios are similar to those of SSE and National Grid, and Centrica’s PE10 of 18.9 is similar to SSE’s PE10 of 19.9.

At its current price, Centrica looks fully valued to me, so I’d rate it no more than a hold, except perhaps for income investors.

Best of both worlds?

Although I don’t see much potential for capital growth from Centrica, the firm’s shares offer a 4.6% dividend yield that has been covered by free cash flow for four of the last six years.

What’s more, Centrica’s energy business provides an opportunity for the firm’s growth to outpace that of its utility peers. In 2012, adjusted operating profit from Centrica’s British Gas business rose by 9%, but the adjusted profits from its energy business, which produces oil and gas, rose by 20% — more than double the growth in the firm’s utility division.

Buy or hold?

I think that Centrica is fairly valued at present, but investors looking for an income that is backed by both a regulated utility business and a growing energy business may want to take a closer look — Centrica’s dividend has risen steadily since 2000 and the firm’s shares offer an attractive 4.8% prospective yield.

Can you beat the market?

If you already own shares in Centrica, then I’d strongly recommend that you take a look at this special Motley Fool report. Newly updated for 2013, it contains details of top UK fund manager Neil Woodford’s eight largest holdings.

Mr Woodford‘s track record is impressive: if you’d invested £10,000 into his High Income fund in 1988, it would have been worth £193,000 at the end of 2012 — a 1,830% increase!

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> Roland owns shares in SSE but does not own shares in any of the other companies mentioned in this article.