Why is this value share getting even cheaper?

Our writer reviews a UK value share that has a very cheap-looking valuation. Does it offer long-term value for his portfolio?

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Different investors have their own way of deciding what constitutes a value share.

Many look at price-to-earnings (P/E) ratios. They can be helpful, but in isolation they do not always tell the full story.

For example, earnings can move around dramatically from one year to the next. A P/E ratio does not reflect how much debt is on the balance sheet, but in the end it is crippling debt that leads some very cheap-seeming shares to lose all their value.

With a P/E ratio of under four, energy provider Centrica (LSE: CNA) certainly looks cheap. The share price has actually been falling and now stands 20% below where it was in September.

Why?

Inconsistent earnings

The problem here is not the balance sheet.

Centrica used to have a lot of debt. But asset sales in recent years have transformed its finances as well as its business.

At the end of last year, the company had net cash of £2.7bn. That gives it a considerable financial buffer. The current market capitalisation is £7.1bn, so the net cash is close to 40% of that.

What about earnings? Here, things look less compelling in my view.

Last year’s earnings of £4bn were huge. Basically, the cost of buying the whole company right now is just a few hundred million pounds more than what it earned last year, combined with its net cash.

But, as is common with value shares, Centrica’s earnings have moved around dramatically. It has only recorded a profit after tax in two of the past five years.

The asset sales I mentioned also mean that some previous sources of earnings no longer exist.

But my main concern about the quality of future earnings at Centrica is the nature of its existing core business.

Set for long-term decline

Its British Gas division remains central to Centrica’s business strategy. But gas usage in the UK is in long-term structural decline. Centrica’s gas supply business is a shadow of what it was even a decade ago. Even so, I expect the downward demand trend to continue relentlessly.

The company’s brands have struggled with a reputation for poor customer service (fairly, in my view), so even in a declining market, the business may lose customers to rivals.

Meanwhile, fluctuations in energy prices can make revenues and especially earnings highly volatile. That is an ongoing risk that I see as baked into Centrica’s business model.

Not the share for me

Still, that does not necessarily mean that the shares do not offer value.

As last year proved, in good times, Centrica can earn well. It is sitting on a massive cash pile.

Over five years, the shares are up 21%. Longer term, though, they have been a disaster. The price is two-thirds below its 2013 level and the dividend has shrunk in that period.

I do not like the market trends in Centrica’s main business and the possible impact of energy price volatility on its earnings. This is one value share I will not be buying.

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.

C Ruane 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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