Shares in Centrica (LSE: CNA) (NASDAQOTH: CPYYY.US) are at their lowest level since the start of 2013, with sentiment worsening significantly since Ed Miliband’s announcement that a Labour government would freeze energy prices for 20 months should it gain power at the 2015 general election.
This could pose a major problem for energy providers such as Centrica because it may mean squeezed margins, with it being unable to pass on higher wholesale energy costs on to consumers. In turn, this could mean lower levels of profit.
Sentiment has clearly been hit hard. Indeed, shares have fallen by 15% since the announcement after they briefly touched 400p — their highest level of all-time.
However, it could be the case that shares have overdone their price fall. Certainly, a slightly disappointing recent update has also knocked sentiment further, with Centrica stating that profits from its retail business are unlikely to be forthcoming, while further projects are also being mothballed and/or cancelled.
The fact remains, though, that over one-third of Centrica’s business is not focused on the supply of domestic energy. Rather, it is centred on finding and exploiting gas reserves around the world.
So, in effect, Centrica is something of a hybrid: part energy supplier and part exploration company.
However, shares have reacted as though the entire business is focused on the supply of energy to the domestic market. For instance, shares in SSE have fallen by 12% since the announcement despite SSE being far more reliant upon the domestic energy market for its revenue. Certainly, it does produce energy but is not a one-third energy exploration business, like Centrica, whose shares have fallen by 15%.
Furthermore, there is no certainty that Labour will win the election and no certainty that, even if they do, they will be able to force through an energy price freeze.
Therefore, a share price of 400p could be achievable over the medium to long term, with Centrica also offering a yield of 5.1% in the meantime. This means that total returns of 20%+ are achievable, simply by Centrica rising back to the price at which it traded before the price freeze announcement from Ed Miliband.
Indeed, the market has assumed that Labour is likely to win the election (partly because it is ahead in the polls) and that, should it win, a price freeze will occur. Both of these events are possible but the market may decide that they are not probable, hence reducing Centrica’s yield to a more acceptable 4.25% and pricing shares at around 400p each.
> Peter owns shares in Centrica.