There’s good news and bad news for Centrica (LSE: CNA) (NASDAQOTH: CPYYY.US) in regulator Ofgem’s call for an enquiry by the Competition and Markets Authority.
Trashed
The once-solid investment case — a vertically integrated utility with a substantial market share in a stable economy — has been trashed in the last 12 months. Indifference toward investment by the Tories, a proposed price freeze from Labour and calls for the sector to be broken up into companies whose “value proposition is to save households energy” by the Lib Dems have turned investment in the sector into a bet on the result of a political football match.
Positively, the referral does take the heat off the Big Six energy companies in the run up to and aftermath of next year’s General Election, as the investigation should protect them from any nasty surprises. In the last two weeks the life assurance sector has shown just how vulnerable to government action share prices can be.
Sober
What’s more, the consequences of a competition review may not be especially adverse. Whilst critics point to the fat 11% margin Centrica made on gas supply in 2012, the same year it made a loss of 1.6% on electricity supply. Competition investigations are soundly based on law and economics: many sober commentators think the sector would get a relatively clean bill of health on margins.
Companies must make profits in order to invest. Centrica CEO Sam Laidlaw has come out fighting, delaying investment in much-needed gas-fired generating plant the day after Ofgem’s referral. He’s not the first industry expert to talk of black-outs. If we are facing 1970s-style rationing by the time the competition authority reports the political mood-music would be different.
The CEO of SSE, Alistair Phillips-Davies, has taken a more subtle approach with a pre-emptive self-imposed price freeze. But the message of his actions was, if anything, more powerful: controlled prices means job cuts, asset sales, reduced investment, and a focus on what government adds to energy bills. VAT and green taxes on the average fuel bill are double operators’ profits.
Break-up and Breakdown
A bigger ‘risk’ for the sector is that a competition enquiry would demand a break-up of upstream and downstream operations. But Centrica’s house broker Goldman Sachs, for one, thinks a break-up would be good for shareholders, though bad for customers. It would expose energy consumers to greater commodity risks but highlight the sum-of-the-parts valuation of the company. Politicians should be careful what they wish for.
Of course the breakdown of trust is a negative factor, and Centrica’s investment strike will slow profit growth. It may compensate by increasing emphasis on international operations. It has recently bought the retail arm of the Irish state gas company and committed to expand in North America.
What happens to Centrica’s share price will be determined by realities and rhetoric. But you can be certain that management will fight hard to maintain the dividend, which on the current price is a thumping 5.5% yield.
