The Centrica (LSE: CNA) share price has recovered from a multi-year low of below 125p hit earlier this year. Nevertheless, it remains relatively depressed, closing yesterday at not much above 150p, compared with 200p this time last year and a high of over 400p five years ago.
Today, the company released its half-year results and its shares head the FTSE 100 fallers board as I’m writing. They’re down 5% to 145p. Adjusted earnings per share (EPS) came in 22% lower than in the same period last year and trailing 12-month EPS now stands at 10.8p. Meanwhile, the board maintained the interim dividend at last year’s level, so the trailing 12-month dividend is 12p.
At the current share price, the price-to-earnings (P/E) ratio is a modest 13.4 and the dividend yield is a whopping 8.3%. These are strong value credentials on the face of it, but let me explain why I continue to see Centrica and fellow FTSE 100 high-yield value candidate Taylor Wimpey (LSE: TW) as stocks to sell.
Headwinds
Chief executive Iain Conn said Centrica “demonstrated resilience” in a first-half of “rapidly rising commodity prices, extreme weather patterns, continued competitive pressures and ongoing political and regulatory uncertainty.”
Group revenue increased 7% to £15.3bn from £14.3bn but adjusted operating profit fell 4% to £782m from £814m. In Centrica’s consumer business — its largest division — adjusted operating profit dropped 20% to £430m. The number of UK residential customers fell by 341,000 over the six months to 12.5m, and while this was 36,000 fewer losses than in the same period last year, the continuing flight of customers is one of the biggest reasons for my bearish view on the company.
Centrica’s management puts the loss of customers down to “the highly competitive nature of the residential supply market.” If so, pressure on retaining customers and on profit margins is likely to continue, with government and regulators determined to keep the market as competitive as possible for the benefit of consumers. Measures to this end are set to include a market-wide price cap of the Standard Variable Tariff and other default tariffs to counter what prime minister Theresa May has called “rip-off prices.”
Cash flow and dividend
Shareholders will have been relieved that Centrica announced it expects to maintain the dividend at 12p this year, although it came with a proviso, “subject to delivering adjusted operating cash flow and net debt in line with our target ranges.” In the case of the former, it delivered £1.1bn in the first half and the full-year target is between £2.1bn and £2.3bn. In the case of the latter, net debt stood at £2.9bn at the half-year-end and the year-end target is between £2.5 and £3bn.
When Iain Conn took up the chief executive role on 1 January 2015, he conducted a strategic review. He concluded that Centrica’s focus should be on its consumer-facing businesses. He slashed the dividend by 30% but said the company aimed to “deliver at least 3% to 5% per annum underlying operating cash flow growth to 2020 … so underpinning a progressive dividend policy.”
The base level for the growth in annual underlying operating cash flow was just over £2bn in 2015. Last year, Centrica delivere … just under £2bn. Meanwhile, the progressive dividend has yet to advance beyond 12p and the consensus of City analysts is for a cut next year. I see a struggling business, running hard just to stand still and facing continuing multiple headwinds. It is for these reasons that I rate the stock a ‘sell’.
Tempting proposition
In contrast to Centrica, housebuilder Taylor Wimpey has enjoyed a long period of booming top- and bottom-line growth. In its half-year results today chief executive Pete Redfern said: “With a strong order book in place, we are confident in our prospects for the remainder of the year and looking further ahead.”
I turned bearish on Taylor Wimpey last autumn. In spite of its low forward P/E (10.1 at the time), I noted that its operating profit margin of 20.8% and price-to-tangible book value of 2.1 times were at levels we tend to see at the boom end of the housing cycle. And with consumer debt at historically unprecedented levels and interest rates moving into a rising cycle, I felt it was a good time to take profits on the housebuilder at 194p.
The market often begins to price-in the next housing bust, even while housebuilders are still reporting robust earnings and City analysts are forecasting continuing earnings growth. As a result, the forward P/E gets lower and the prospective dividend yield higher, and the stock appears a very tempting proposition. I see this happening now, with the shares currently trading at around 175p and the forward P/E down to 8.5 and dividend yield up to 8.7%.
Time to be prudent
Many of my Foolish colleagues are tempted by Taylor Wimpey’s ‘cheap’ valuation in the belief that the market’s got it wrong in starting to price-in a significant downturn. However, since pointing to the risks of record levels of consumer debt and rising interest rates back in November, I’m seeing further worrying signs that the housing market (and housebuilders) could be heading for trouble.
Consumer confidence isn’t great as an uncertain Brexit looms nearer. When people fear house prices could fall, the risk of taking on a mortgage seems higher and they put off buying. There has also been a big rise in banks valuing properties for less than their sale price. Indeed, the number of so-called ‘down valuations’ has increased from one in 20 to one in five over the last two years, which is the highest level since the 2008 financial crash. We’re not yet seeing reduced mortgage availability and stricter lending criteria, but it could be coming over the horizon.
Housebuilders (and their shareholders) have enjoyed a terrific period of boom, but this a notorious boom-and-bust industry. With “it’ll be different this time” being probably the most dangerous belief an investor can adopt, I continue to see Taylor Wimpey as a stock to sell. There’s a time to be greedy and a time to be cautious with highly cyclical stocks, and I lean towards the latter at this stage.
