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The Contrary Investment Case: 3 Reasons To Shun Centrica plc

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In recent days I have looked at why I believe Centrica (LSE: CNA) (NASDAQOTH: CPYYY.US) is poised to surge skywards.

But, of course, the world of investing is never a black and white business — it takes a variety of views to make a market, and the actual stock price is the only indisputable factor. With this in mind I’m going to lay out the key factors that could, in fact, undermine Centrica’s investment appeal.

Political turmoil set to last

I have long argued that the will of politicians to curb the profitability of the country’s ‘Big Six’ energy providers remains at odds with what they actually say when the cameras begin rolling. The issue of utility price escalation is hardly a new phenomenon, yet Westminster has failed to act in previous years, possibly due to the large levels of investment needed to keep the grid up and running.

However, the debate will still not go away. Just last month Labour’s shadow energy secretary Caroline Flint reiterated the party’s intention to freeze prices for 20 months from 2015 if it wins the next election. Continued uncertainty could prompt further weakness in the share price, while Centrica and its peers may be forced to scale back dividend growth as part of an ongoing PR battle.

British Gas on the retreat

Possibly worsened by this backdrop of bad press, Centrica has seen demand for its electricity and gas services in the UK decline during the last 12 months. Indeed, its British Gas subsidiary saw its residential customer base decline 2% to 15,256 accounts, and the company has initiated a number of measures — including price reductions and the introduction of simpler tariffs — in order to resuscitate its fortunes here.

This reduced client demand helped push British Gas’ operating profit for residential energy supply 6% lower in 2013 to £571m, while supply and services to businesses collapsed 19% during the period to £141m. Higher commodity expenses and rising costs elsewhere were a further burden on performance last year, Centrica noted, issues which may also continue to drag on the bottom line.

Problems persist across the Atlantic

Meanwhile, Centrica is also witnessing problems at its Direct Energy downstream operations in the US, and saw operating profit slip 11% here during 2013 to £276m.

Specifically the business noted that

rising gas and power prices, declining barriers to entry and an increasingly competitive environment among both competitive energy suppliers and default utility providers led to a narrowing of margins.”

Centrica is going to have to pull out all the stops to rectify these issues and get its North American division back on track.

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Royston does not own shares in Centrica.