I’ve gone on record as being a buyer of British Gas owner Centrica (LSE: CNA). Ahead of this year’s results I was bullish about the chances that the outlook might start to improve.
However, the market reaction to last week’s figures was poor, probably because the outlook for 2019 was downgraded. And although I don’t sell a stock just because it falls, I think it makes sense to revisit my investment case after a poorly-received set of results. There’s always a chance that I’ve missed something, or that the story has changed.
In this article I want to take a fresh look at the facts and explain what I’m going to do with my Centrica shares.
The story so far
You wouldn’t know it from last week’s share price slump, but, Centrica’s adjusted pre-tax profit actually rose by 25% to £1,119m last year.
If we look at the statutory figures, which include various one-off items excluded from the adjusted figures, pre-tax profit rose by 319% to £575m!
Both sets of figures seem to suggest a business where profits are recovering. But the shares have fallen by nearly 10% since these figures were published. So are things improving, or getting worse?
Progress is being made
The most high-profile problem facing the group is that its British Gas division is losing customers fast. Customer numbers have fallen from 27.4m at the end of 2015 to just 25.1m at the end of 2018.
However, it’s worth keeping this in context. British Gas is still the energy supplier for a large part of the UK population. And customer departures slowed to 249,000 in 2018, with just 23,000 accounts lost during the second half of the year. A raft of smaller energy firms have failed over the last year as energy prices have risen. The tide might be turning in favour of larger suppliers again.
Elsewhere, there’s genuine growth. The number of customers signed up to the group’s Connected Home business rose from 900,000 to 1,344,000 last year. Business customers signed up to the Distributed Energy & Power service — which helps customers harness renewables and balance supply and demand — rose by 16% to 5,560. Revenue from these two growth businesses rose by 23% to £276m.
The dividend question
The big question for shareholders is whether the group’s dividend will be cut. Chief executive Iain Conn left the payout unchanged at 12p per share for 2018. My calculations show that this should be covered by 2018 free cash flow — just.
However, there’s no doubt the company’s ability to fund the dividend from its cash flow is getting very tight.
Mr Conn’s guidance for 2019 suggests that the group’s adjusted operating cash flow will fall from £2.2m to between £1.8bn and £2bn. He hopes to make up the shortfall with an extra £250m of cost savings and £500m of non-core asset sales. If this approach is successful, net debt should stay between £3bn and £3.5bn.
If the group fails to meet these targets, I think a dividend cut will become unavoidable. However, with the stock now yielding more than 9%, I’d argue that the market has already priced in a cut.
My view: I sold a few of my Centrica shares after last week’s results, but I still have the bulk of my holding. I’ve decided to hold for now, but I won’t be buying any more shares.
