The Surprising Buy Case For Centrica plc

Today I am looking at an eye-opening reason why massive capital reserves are set to propel earnings in Centrica (LSE: CNA) (NASDAQOTH: CPYYY.US) higher over the medium to long term.

Cash pile mobilised to blast earnings skywards

Centrica is perhaps best known as the proprietor of the UK’s gas and electricity behemoth British Gas. But the company is also expanding aggressively into the US retail sector and steadily building its upstream businesses both in the British Isles and in North America. Centrica is in huge part able to achieve this through its substantial cash reserves, which should facilitate excellent earnings growth.

In the first six months of 2013, Centrica chalked up total operating cash flow — minus working capital movements — of £2.06bn. This was up substantially from £1.68bn in the corresponding point last year and was thanks to acquisitions made in 2012. And Liberum Capital expects cash flow “to expand further in coming years in our view as the cashflow from recent upstream investments feed through”.

As well as providing a buffer in case of possible revenues weakness, this has enabled the firm to maintain its commitment to returning oodles of excess cash to its investors, achieved through offering above-average dividends and a £500m share buyback scheme for the current year.

But more interestingly, Centrica has outlined that it is pursuing “a range of investment options” in which to devote its burgeoning capital pile. More specifically, the business has picked out a plethora of upstream and downstream options in North America as key drivers for future earnings growth.

The firm’s bid to double profitability at its Direct Energy retail division by 2018 saw it purchase Hess’ Energy Marketing business in July for $731m plus approximately $300m in net working capital. But Centrica is also looking to develop early-stage oil and gas assets across the Atlantic, and the April acquisition of Suncor’s Canadian energy assets for £650m in partnership with Qatar Petroleum International gives it access to massive fuel reserves.

Although Centrica has been busy on the M&A front, it is also devoting vast sums to organic investment — indeed, the company shelled out in the region of £700m in January-June to bolster its existing assets. This has enabled it to bring online promising oil and gas projects in the North Sea and Irish Sea, while it is also close to finishing commissioning of its £1bn Lincs offshore wind farm. I fully expect the firm’s cash pile to underpin strengthening earnings growth well into the future.

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> Royston does not own shares in Centrica.