Should I buy the Centrica share price at a 21-year low?

G A Chester sees a contrarian case for buying into British Gas owner Centrica plc (LON:CNA) and a FTSE 250 turnaround prospect.

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British Gas owner Centrica (LSE: CNA) saw its shares fall through the 100p level in May. The price has continued to decline, and made a new 21-year low of just over 86p at the backend of last week.

Meanwhile, outsourcer Capita (LSE: CPI) has nudged back above the 100p mark after a recent dip below, but is another stock where you have to go back to the 1990s to find it last trading as low.

On the face of it, these look like two of the least-promising investment prospects in the FTSE 100 and FTSE 250, respectively. However, I think there’s a case for hardened contrarian investors to buy at these depressed prices.

All in the price?

A competitive trading environment, a recent regulatory price cap, and variables like weather and gas prices have all contributed to Centrica’s disappointing performance. However, its discount valuation relative to sector peer SSE, which faces similar headwinds, has me interested.

 

Forecast P/E (current year)

Forecast P/E (next year)

Forecast dividend yield (current year)

Forecast dividend yield (next year)

Centrica

10.7x

8.6x

9.1%

9.1%

SSE

12.4x

10.8x

7.1%

7.3%

Centrica will be releasing its half-year results and a strategy update later this month. According to my sums the valuation, relative to SSE, implies the market is pricing in grim news. There’s a 13% downgrade to current-year consensus earnings forecasts, a 21% downgrade to next year’s, and a dividend cut of the order of 45-50%.

It strikes me that if all this is already in the price, further downside would require a monster profit warning and suspension of the dividend.

However, if current consensus forecasts for earnings (8.2p this year and 10.2p next year) and dividends (a 33% cut to 8p) are maintained, and the stock rerates to something like SSE’s valuation, we’d be looking at a share price in the region of 100p-110p.

Picking up pennies in front of a steamroller or a decent risk-reward contrarian play? I’m leaning towards seeing it as the latter.

Historic clouds clearing?

Capita was at one time a FTSE 100 company and a market darling. However, like many in the outsourcing sector, its business unravelled quite spectacularly a few years ago. As a result, a lot of investors probably wouldn’t give it a second glance today.

I think it could be time to forget the past and look at Capita afresh. Refinanced and under new management, the company successfully completed year one of a three-year turnaround plan in 2018. Now halfway through year two, we’ve had no update on trading since the annual results were released in March. So it looks like the company is on track to achieve its goals and guidance for this year too.

Management has done a good job so far and has a credible strategy to achieve its 2020 targets of double-digit profit margins and at least £200m of sustainable annual free cash flow. However, I think historic clouds are perhaps still hanging over market sentiment at this stage. On City consensus forecasts of 12.7p earnings this year, followed by 20% growth to 15.2p next year, the P/E is a dirt-cheap 8.4, falling to just 7.

I reckon the stock could be a good contrarian buy at the current level, with prospects of both improving investor sentiment and trading performance driving returns.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

G A Chester has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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