Why Centrica PLC Remains A Buy Despite Falling Investment

Today I am looking at why I believe Centrica‘s (LSE: CNA) (NASDAQOTH: CPYYY.US) earnings outlook remains rosy despite plans to significantly scale back capital expenditure.

Capital expenditure set to decelerate

A confluence of problems, from rising wholesale prices through to barking from Westminster, have made life extremely difficult for Centrica over the past year. The owner of British Gas saw operating profit slip 2% lower during 2013, to £2.7bn, as utility bill hikes saw consumers switch suppliers and wholesale prices continued to climb.

Amid these difficulties, the electricity giant has vowed to get tough on total upstream spend due to rising costs and lower gas and oil prices. Centrica has promised to take a more selective approach to capital expenditure, and plans to slash exploration and production spend by a fifth, to around £900m, per year over the next three years. This compares with the £2.6bn forked out in 2013 alone.

As well, difficult market conditions has also forced Centrica to rein in spending on UK power generation. The sale of its Race Bank wind project centrica / sseand decision not to invest in nuclear plants reflects the firm’s view of the domestic market, and Centrica advised that any investment in gas-fired plants will “depend on the economics of the projects and the successful introduction of a capacity market, including an assessment of the political risk.”

The company is not averse to flashing its wallet at ventures which it considers as offering tremendous value.  Indeed, Centrica announced today that it was part of a consortium to acquire vertically integrated supplier Bord Gáis Energy (BGE), Ireland’s largest dual-fuel energy provider, for £920m.

The purchase of BGE’s electricity and gas supply business, as well as the Whitegate gas-fired power station, will allow Centricato bring innovative propositions from our US and UK downstream operations and the potential to increase BGE’s offering in energy services,” the company noted.

Earnings rebound anticipated next year

Centrica is set for further earnings woe in the medium term, and City analysts have pencilled in a 6% earnings drop for 2014. However, improving market conditions are anticipated to prompt a 5% earnings recovery in the following 12-month period.

Of course question marks over heavy profit-curbing measures, and possibly the break-up of the largest energy suppliers, by Ofgem continues to dominate investor sentiment for the UK’s listed utilities.

Consumer group Which?, in alliance with the Federation of Small Businesses, called for the regulator to launch a probe into a perceived lack of competition in the British energy market. This prompted industry trade body Energy UK to fire back, claiming that the 18 domestic suppliers currently in operation represents the highest number for almost a decade.

Investors can expect the debate to rage right up until the 2015 general election and beyond. Still, in my opinion the government’s requirement for Centrica et al to chuck vast sums at upgrading the power network is likely to temper their desire to hamper such firms’ profit levels. Meanwhile a more disciplined approach to capital expenditure should boost shareholder returns over the long-term.

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Royston does not own shares in Centrica.