It’s safe to safe that Centrica (LSE: CNA) (NASDAQOTH: CPYYY.US) has had a tough start to the year. The company has come under a barrage of criticism from politicians, with some even calling for the company to be split up, to give customers a fairer deal.
However, while investors are right to be concerned about political intervention in the energy sector, it is unlikely that Centrica will be broken up, leaving the company looking undervalued.
A split-up is unlikely
The threat to break up Centrica is likely to be nothing but political hot air, as initial indications imply that customers will actually be worse off if the split goes ahead.
You see, due to Centrica’s size, market dominance and reputation, the company has been able to negotiate long-term energy supply contracts with several major gas companies. In total, these contracts are worth more than £60bn, four times the size of Centrica’s current market capitalisation. Nevertheless, Centrica has been able to negotiate these contracts at attractive prices, which are for the most part being passed onto customers.
As a result, if Centrica were to be split up these contracts would dissolve and it is likely that a smaller company would be unable to secure similar contracts.
So, a split up of Centrica is likely to only increase prices for customers, indicating that it is unlikely to go ahead. That being said, it is possible that instead of a break up the regulator will cap the amount of profit Centrica is able to make from retail customers.
Plenty of room for growth
Even if a break-up doesn’t go ahead, many investors believe that Centrica’s future growth prospects are slim but this is not the case.
Indeed, it appears as if Centrica has plenty of room to expand around the world with the company’s UK operations provide a great springboard to support this growth. In particular, most of Centrica’s growth efforts are focused around Direct Energy, Centrica’s Canadian gas business bought in 2000, now one of the largest retail energy suppliers in North America. Centrica’s management has set a target of doubling Direct Energy’s profits during the next three to five years.
Moreover, Centrica owns operational gas and oil fields from which the company produced nearly 80m barrels of oil during 2013, giving the company an operating profit of around £1.2bn. Production from these assets is only likely to grow.
Valuation is attractive
So, as Centrica is unlikely to be broken up and the company has plenty of scope for international growth the recent sell-off makes the company attractive on a valuation basis. Specifically, at present the company trades at a historic P/E of 12 and a forward P/E of 11.9 for 2015, making Centrica one of the cheapest company’s in the FTSE 100.
In addition, at present levels Centrica offers a 5.3% dividend yield, which City analysts believe could rise to 5.6% this year. The payout is covered one-and-a-half times by earnings.
Foolish summary
Overall, based on Centrica’s low valuation and international growth prospects the company is a clear-cut buy for me at these levels.
