Up 224%, has the Centrica share price hit boiling point?

The Centrica share price just keeps getting stronger. But has it gone too far, and could investors get burned? Dr James Fox explores.

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The Centrica (LSE:CNA) share price is among the best performers on the FTSE 100 over the past few years. Over one year, the stock is up 101%, over two years it’s ahead by 224%, and over three years, 279%.

The stock has staged a recovery to equal Rolls-Royce, but still trades below its pre-pandemic highs above £3 a share. So, has the share price got further to run, or could interested investors get their figures burned?

Profits surge

Centrica shares surged after H1 results in July. The energy provider reported that adjusted pre-tax operating profit had risen from £1.3bn to an impressive £2.1bn.

Meanwhile, earnings per share climbed from 11p to 25.8p, and statutory operating profit showed substantial growth from -£1.1bn to £6.5bn.

The jump in performance was attributed to higher energy prices versus previous locked-in contracts and hedges.

An adjustment to the energy price cap also positively impacted earnings. Operating profits at the British Gas unit surged 889%, reaching £969m.

As noted by CEO Chris O’Shea: “In total, the positive impact of recovery of prior period costs through price cap allowances in H1 2023 was approximately £500m.

Is it sustainable?

Centrica anticipates that the majority of its earnings will be weighted towards the first half of the year. As such, we can assume that EPS of 25.8p per half year is unlikely to be sustainable.

However, while this may prove pure speculation, it’s likely that energy prices, both wholesale and household, will remain high over the next decade.

That forecast is based on macroeconomic trends, increasing resource scarcity, and the impact of ongoing conflict, notably Russia’s invasion of Ukraine and its impact on energy security.

So, while we may see ongoing volatility, it’s fair to say long-term trends appear to be upwards.

However, energy is known as cyclical industry for a reason. While energy prices are once again ticking upwards, a global recession could put an end to this, in turn lowering Centrica’s ability to maintain margins.

Strong fundamentals

Before the H1 earnings, JPMorgan forecast that the British Gas owner would likely hold 40% of its then market value in net cash by late 2024.

This would represent quite a significant cash in hand position, around £3bn. It’s also a huge turnaround from its net debt position of £3bn in 2020.

In the energy industry, a cash buffer is particularly important given the volatility involved in the energy systems industry.

Moreover, a strong cash position not only allows companies to pounce on opportunities but facilitates ongoing investments in this capex-intensive industry.

Valuation

Even after surging 224%, the stock trades at approximately 4.3 times forward earnings. While energy and cyclical firms typically command lower valuations, this represents an attractively low one.

It’s worth highlighting also that the firm’s forecast cash position could mean further buybacks and enhancements to the dividend policy. As it stands, the dividend yield sits just shy of 2%, some way below the index average.

While potential risks persist that could dent the share price, the long-term outlook appears favourable, indicating the possibility of additional increases in the price as investor sentiment improves.

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.

JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. James Fox 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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