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?

| More on:
Businesswoman calculating finances in an office

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

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.


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.

More on Investing Articles

Close-up of British bank notes
Investing Articles

£8 per year in extra income for life, for each £100 invested today? Here’s how!

Christopher Ruane explains how he would aim to set up extra income streams for the rest of his life by…

Read more »

Photo of a man going through financial problems
Investing Articles

With a £20K Stocks and Shares ISA, I’d target £1,964 in annual dividends like this

With an annual passive income target close to £2,000, our writer explains how he'd put a £20K Stocks and Shares…

Read more »

Illustration of flames over a black background
Investing Articles

Down 63% in 2024, what’s going on with the Avacta (AVCT) share price?

2024 has been a difficult year for many companies in the biotechnology sector, with the AVCT share price down heavily.…

Read more »

Warren Buffett at a Berkshire Hathaway AGM
Investing Articles

Here’s how I’d invest £800 the Warren Buffett way!

Christopher Ruane learns some lessons from super-investor Warren Buffett he hopes could improve his own stock market performance.

Read more »

British Isles on nautical map
Investing Articles

Michael Burry just bought 175,000 shares in this FTSE 100 company

Scion Asset Management announced a $6.5bn stake in BP this week. But what could Michael Burry be seeing in an…

Read more »

Young Asian woman holding a cup of takeaway coffee and folders containing paperwork, on her way into the office
Investing Articles

£5,000 in savings? Here’s how I’d aim to start making powerful passive income today

With a cash lump sum to invest, this Fool lays out how he'd start making passive income. He also details…

Read more »

Investing Articles

Just released: our 3 top small-cap stocks to consider buying before June [PREMIUM PICKS]

Small-cap shares tend to be more volatile than larger companies, so we suggest investors should look to build up a…

Read more »

Passive income text with pin graph chart on business table
Investing Articles

My best FTSE 250 stock to consider buying now for passive income while it’s near 168p

This is a rare stock with a growing underlying business and a fat dividend yield – it’s worth consideration for…

Read more »