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High Returns Make Me Optimistic About Centrica PLC

Centrica (LSE: CNA) (NASDAQOTH: CPYYY.US) is delivering for its shareholders and, as such, I’m thinking about increasing my stake in the company.

For instance, last year return on equity was a very impressive 17%, which shows that for every £1 of shareholder equity in the firm, Centrica generated 17p of net profit. This is not only a relatively high figure but, in my view, is sustainable as a result of the stable nature of the vast majority of Centrica’s business.

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Furthermore, return on equity has averaged 20% during the last three years, again highlighting the consistency of the business. Indeed, a narrow range of return on equity further indicates that such figures are not only strong but can be expected to occur again in future, with a low of 17% and a high of 21% being recorded over the last three years.

However, an attractive return for equityholders is not the only reason why I’m thinking of buying more shares in Centrica.

Indeed, I also feel that shares offer great value at current levels, as highlighted by the free cash flow yield of 5.6%. This is relatively high but could be higher were it not for the capital intensive nature of the business, with capital expenditure making a significant dent in free cash flow.

However, despite this, the free cash flow yield is still well above many of Centrica’s sector peers and also other less capital intensive business that are also constituents of the FTSE 100.

In addition, Centrica has focused in recent years on improving the quality of its asset base. This has been time (and money) well spent in my view, as just over one-third of the business is focused on exploration rather than the provision of energy.

So, a key part of any exploration company is not only having the ability to develop assets but the right assets in the first place. Centrica’s balance sheet has certainly improved in recent years and now provides shareholders, in my opinion, with a viable long term exploration and production business and not just a supplier of energy to the domestic market.

So, I’m optimistic about Centrica’s prospects and am thinking of increasing my stake in the company because I believe it will continue to deliver high returns for shareholders, is currently good value (as shown by the free cash flow yield) and has a strong asset base that has improved in recent years.

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> Peter owns shares in Centrica.

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