“Centrica (LSE: CNA): double upgrade from underperform to outperform, target raised from 240p to 320p,” was the headline from Royal Bank of Canada (RBC) today.
From sell to buy and all in one go. Are you impressed?
Be patient. With Centrica’s share price currently at 275p, that’s a 16% upside for a company that also offers a rich yield — but how does it compare with the capital gains that a growth company such as ASOS (LSE:ASC) or a defensive business such as AstraZeneca (LSE: AZN) could offer?
Centrica: not cheap enough
Centrica is now RBC’s “preferred UK utility and among our favoured European names,” the broker said today, adding that it expects a compound annual growth rate for earnings at 6% and a strong free cash flow on the back of a stronger outlook for its retail operations.
The double upgrade boosted the stock, which was up 1.5% to 275p at the time of writing.
My view is that Centrica is not cheap enough to deserve your attention right now. It’s as yet unknown if its core margins will expand in future, which is a key assumption for analysts at RBC.
Furthermore, its rather lowly valuation, which currently stands at about 10x forward earnings (P/E), fully reflects the risk of investing in it rather than the opportunity of securing a fantastic bargain, in my opinion. Even though Centrica chopped its divided earlier this year, dividend risk is alive and well, and there’s no growth in the business.
I need growth potential to invest in equities, so one obvious name springs to mind here: ASOS!
ASOS: not too expensive
As I have argued in the past, ASOS could well be the right investment at 3,000p–3,500p a share if you’re looking for a growth candidate. Its stock currently trades at about 3,400p, which implies stellar forward P/E multiples of 80x and 60x, respectively, over the next two years.
Its balance sheet doesn’t carry any debts, while heavy capital requirements are low in the light of its core online business, so your full attention must be devoted to identifying trends for sales and margins — neither of which are very safe, in my opinion. But if ASOS manages to invest while growing its sales and margins over time, it’ll easily reward your efforts.
In a conference call with analysts after quarterly results were announced earlier this month, chief financial office Nick Beighton discussed full-year 2015 guidance, arguing that he expected “sales to be towards the top-end of my range 15% to 20% range … while still maintaining our EBIT guidance of 4%.“
“Within that our strong period performance were largely gross margin flat year-over-year, accordingly we’ve accelerated investment in our people capability and our customer propositions.”
We’ll see how this one goes.
AstraZeneca: could become cheaper
AstraZeneca stock is still overvalued by about 20%/25%, according to my calculations, but I’d probably bet on it rather than on the shares of Centrica.
Why? I prefer Astra’s management team.
Moreover, I never buy stocks that are cheap based on trading multiples, unless their fundamentals are attractive, but I am attracted to stocks that trade high based on low earnings projections, such as Astra’s stock. Quite simply, that’s because it may become much easier to beat estimates over time.
If Astra meets market forecasts, it will unlikely deliver significant capital gains to its shareholders, but if its earnings profile improves, its rich valuation of almost 30x net earnings could become much more appealing. Astra’s interim results are due on Thursday and I suggest you keep an eye on them.
