British Gas owner Centrica (LSE: CNA) has a problem. It’s losing customers, and those it’s managed to hold on to aren’t using as much energy as they did last year. The solution? Increase electricity prices by 12.5% from September.
This decision, which was announced alongside the group’s half-year results this morning, sent the share price up by 3% in the first hour of trading. Customers may not be celebrating, but it seems investors are.
British Gas is still big
Although this isn’t the place for a debate on energy prices, it’s interesting to note that Centrica said today that it hasn’t increased its standard electricity tariff since November 2013, even though “overall electricity costs” have risen by 16% since 2014.
I’m not completely sure what’s included in this measure of costs. But it may be that the firm’s charges will still look fairly reasonable alongside those of its main competitors.
What is certainly true is that the firm needs to do something to support its profit margins. British Gas has lost 540,000 UK customers over the last 12 months, which is a drop of 2.5%. During this period, average energy use per residential customer account has fallen by 8%.
Adjusted operating profit from was £489m during the first half of 2017, down by 23% from £635m for the same period last year. But despite this fall, British Gas remains Centrica’s largest source of profits, accounting 60% of the group’s H1 operating profit of £816m.
Too cheap to ignore
Some of the UK weakness was offset by growth elsewhere during the first half of the year. Centrica’s energy marketing and trading division generated an operating profit of £105m, compared to a loss of £14m last year. In North America, profit rose from £95m last year to £172m during the first half of this year.
I think it’s fair to assume that management will be able to address the challenges facing the British Gas business. Given that the remainder of the group appears to be performing well, Centrica stock looks cheap to me.
The shares currently trade on a 2017 forecast P/E of 12.7, with a covered dividend yield of 6%. I believe the stock rates as a buy at current levels and recently bought some myself.
I’ve sold Tesco
I’m not sure that there is such good value on offer at Tesco (LSE: TSCO). The UK’s largest supermarket group has made excellent progress over the last couple of years, but much of this seems to already be priced into the stock. The shares currently trade on 18 times forecast earnings, with a prospective yield of just 1.9%.
Admittedly this is a very large company. A turnaround was always going to take time. But what’s not clear to me is how much progress Tesco will be able to make in rebuilding its profit margins. Its underlying operating margin rose from 1.8% to 2.2% last year. Chief executive Dave Lewis is targeting an operating margin of 3.5% to 4% by 2019/20.
That’s quite a demanding target, but my calculations suggest that much of this improvement is already priced into the shares. So although I think Tesco shares remain a worthy hold for long-term income investors, I think there’s a risk the stock will underperform the wider market.
