The Centrica (LSE: CNA) share price has risen by more than 40% so far this year. The owner of British Gas is finally starting to win back investor confidence.
Centrica shares are still more than 65% lower than they were five years ago. But I think there are good reasons to be confident about the outlook for the business over the next few years. I’ve been taking a fresh look at Centrica to see where I think the stock could be in five years’ time.
British Gas is set for growth
Chief executive Chris O’Shea took charge of a business with too much debt and too many moving parts. These problems have now largely been fixed, with the sale of the Direct Energy business in the US and the company’s North Sea oil fields.
The main part of the business remaining is British Gas, which has a strong focus on UK consumers. The last few years have been tough for the UK’s largest energy supplier, as it’s been undercut by smaller rivals offering cheap fixed price deals.
However, the failure of more than 20 of these rival suppliers over the last year has changed the picture. British Gas has picked up more than 400,000 new customers from failed firms. I think its prices will be more realistic and competitive in the future, as unsustainably cheap deals have been removed from the market.
Alongside this, I expect British Gas to increase sales of services such as boiler replacement, air source heat pumps, home emergency cover and smart security products. These services are generally more profitable than selling electricity and gas, so they should help to lift Centrica’s profits.
Centrica share price: where next?
Centrica shares traded at over 200p five years ago. But Mr O’Shea’s changes have left the group a smaller business than it was. Some problems remain too — not least the company’s £1.5bn pension deficit, which will require £175m in annual payments from 2021 to 2025.
What might Centrica shares be worth in five years’ time?
Broker forecasts suggest that the group’s free cash flow — a surplus cash produced each year — could rise to around £700m over the next couple of years. My guess is that progress might slow after this, but if Mr O’Shea’s plans are successful, I reckon a figure of £750m looks reasonable by 2025.
The last time Centrica produced this much free cash was in 2018. At this time, the share price was around 150p. I think that’s a reasonable estimate today.
However, one risk I’d flag up is that the company’s reduced dividend could hold back progress. Back in 2018, dividend cover had fallen to just one times earnings. This resulted in a tempting 7%+ dividend yield.
Mr O’Shea is expected to keep dividend cover at around two times earnings. This is a sensible move, in my view, but it means that payouts will be smaller, even if profits return to historic levels.
As a result, the dividend yield is likely to be much lower. This might deter some investors, but even so, I think Centrica shares could do well over the next five years. I’d certainly consider buying the shares for my portfolio at current levels.
Roland Head 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.