At face value, Centrica (LSE: CNA) looks like a gusher of money. Centrica profits in the past six months alone came in at over £1bn. The company is debt-free. Yet the company has a market capitalisation of only £5.1bn.
At first glance, that looks like an incredible valuation. If second-half profits are as strong, the shares are trading on a prospective price-to-earnings ratio of less than three. Is this a bargain I should buy to help fund my retirement with its bumper profits paid out as dividends?
Some luck, some strategy
Energy prices have been booming. As an energy supplier and owner of brands such as British Gas, Centrica can profit handsomely from increasing energy prices. Indeed, that helps to explain much of the strong performance. The company noted that it had seen “strong Upstream volumes against a backdrop of higher commodity prices”.
The company also has a trading division, so higher energy prices can be a double-edged sword, depending on what trades it makes. Indeed, the potential for trading losses are one of the risks I continue to see for Centrica shares. But for this period, the business said that increased commodity volatility was “handled well” by the trading division.
But it’s not just that Centrica happened to be in the right place at the right time. In the past several years it has slimmed down, cleaned up its balance sheet and sharpened its strategic focus. That is increasingly looking like a good move for which management deserves credit.
Where next for Centrica profits?
What happens next? In short, nobody knows.
For now at least, energy prices remain very strong. They may even increase from here, boosting Centrica profits further. At some point they will turn downwards again. That could be next week – but it might also not happen for years. Meanwhile, high prices help support Centrica profits.
Meanwhile, I expect structural demand for gas in the UK to decline in coming years. That poses a big challenge for Centrica. Higher prices can help offset a fall in customer numbers for some time, but not forever. In the first half, customer numbers actually increased slightly. But they remain far below where they were a few years ago and the long-term trend is downwards.
High profits at a time of sensitivity about fuel prices also give Centrica a headache by adding political risk. If it looks like profiteering (and perhaps even if it does not), the government may cap prices or impose taxes in a way that cuts profits.
I do not regret selling
I sold my Centrica shares this year because I dislike the political risks the company faces and the long-term demand outlook. I also felt the company’s enthusiasm for restarting dividends seemed weak.
The interim dividend was finally restored yesterday, albeit at just 1p per share. Given how much cash Centrica is generating with a debt-free balance sheet, I think it could afford a much bigger payout. But that is politically sensitive.
For now, I think the profit outlook for the firm remains strong. But I would prefer to power my retirement with dividends from a business that is set to see growing demand and where bumper earnings are less of a political football. I have no plans to buy the shares again despite surging Centrica profits.
