I reckon that Centrica (LSE: CNA) shareholders could be in for a rocky ride over the next year, and I suspect that the firm’s CEO is likely to be the next high-profile casualty.
Sam Laidlaw has had a good run at Centrica, successfully refocusing the group on its energy businesses, while delivering a 62% increase in the dividend since 2006.
However, he now faces the triple challenges of an energy market review, a possible energy price cap if Labour is elected in 2015, and the difficulty of planning corporate strategy when faced with the UK’s non-existent long-term energy policy.
Centrica’s highly regarded finance director, Nick Luff, has already handed in his notice, and I wasn’t surprised to read a recent report in The Telegraph, from an ‘impeccable source’, suggesting that Mr Laidlaw will also have announced his departure by the end of 2014.
The question of profits
Centrica’s main UK-listed peer, SSE, has taken a pre-emptive approach to the energy market review, announcing spending cuts and a retail price freeze until at least 2016.
Centrica has taken a more bullish approach, refusing to agree to a price freeze on the grounds that it would limit the firm’s ability to manage changes in underlying wholesale energy costs.
However, this argument starts to look weak when you consider that British Gas reported an operating margin of 7.2% last year. In contrast, SSE’s retail division reported an operating margin of just 4.1% in 2012/13, the last full year for which figures are available.
Bad news isn’t priced in
Centrica seems to be gambling that the energy market review won’t affect its pricing power, and that any energy price cap won’t be onerous enough to affect its profits. However, even analysts’ forecasts, which tend to lag events, are forecasting a modest decline in earnings per share over the next two years, and I think the reality might be worse.
In my opinion, any reduction in Centrica’s profit margins is likely to result in the cancellation of the firm’s share buyback programme, and a dividend cut; both of these measures are already largely funded with debt, which has risen by 60% since 2009.
My view is that Centrica’s dividend may eventually be cut to around 12p per share. On this basis, the maximum I’d pay for Centrica shares is 300p, which would provide a 4% yield.
