Is Centrica PLC Dependent On Debt?

Are debt levels at Centrica PLC (LON: CNA) becoming unaffordable and detrimental to the company’s future prospects?

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centrica / sse

Shares in Centrica (LSE: CNA) (NASDAQOTH: CPYYY) have made a disappointing start to 2014.

Indeed, while the FTSE 100 has recovered from its emerging market ‘wobble’ (where investors questioned the long-term sustainability of the emerging market growth story) to post gains of 1.5% so far this year, Centrica is down 7.8% at 320p.

Although yesterday’s full-year results showed a dip in annual profits of 2%, shares haven’t reacted all that strongly. This could be because of company guidance, with much of the disappointment being priced in, or simply because the market feels shares offer good value at current levels.

However, a key point for investors could turn out to be whether Centrica is financially sound enough to be able to survive over the long run. Or, is it just dependent on debt?

Excessive debt?

With a debt to equity ratio of 115%, Centrica’s financial gearing levels appear to be high, with every £1 of net assets being matched by £1.15 of debt. However, when the nature of its business is taken into account (the supply of energy to consumers) it could be argued that Centrica is able to withstand higher levels of borrowing than most companies on the FTSE 100. In other words, relatively stable profits mean that a higher amount of debt can be accommodated onto Centrica’s balance sheet.

Comfortable headroom

Of course, not all of Centrica’s business is concerned with the supply of energy to customers. It still has an exploration arm, so its debt levels should perhaps not stretch to those seen at sector peer National Grid (which has a debt to equity ratio of 275%). However, its current levels appear to provide the business with sufficient headroom when making the interest payments on its debt. For instance, Centrica was able to pay the net interest on its debt over seven times in 2013, highlighting the fact that the company is unlikely to come under significant pressure when interest rates (finally) rise and the cost of debt subsequently increases.

Looking ahead

Although 2013’s results may have been of slight disappointment, Centrica remains a financially sound business. Trading on a forward price to earnings (P/E) ratio of under 12, Centrica could yet be a strong performer over the remainder of 2014.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

> Peter owns shares in Centrica.

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