Shares in British Gas owner Centrica (LSE: CNA) look dirt-cheap compared to the stock’s trading history. Indeed, the stock is down around 50% over the past 12 months, which suggests the shares could jump as much as 115% if they return to their year-end 2018 level of 150p.
Unfortunately, I think the chances of this happening are quite slim. While the stock might look cheap compared to its past trading history, the company’s underlying fundamentals tell a different story.
Over the past two years, Centrica’s earnings power has crumbled. In 2017, the company reported normalised earnings per share of just under 26p. The figure fell to 15p in 2018 and City analysts expect it to drop further in 2019. They’ve pencilled in earnings per share 6.9p for the year as a whole.
While analysts do expect Centrica’s profits to recover in 2020 (they’re currently forecasting earnings of 9.4p per share for the year) there are so many headwinds facing the business right now, it doesn’t make much sense to me to invest in these figures.
As we’ve seen over the past two years, Centrica’s fortunes can change rapidly over the space of 12 months. So, investing in the business based on predictions for the next 12-24 months may end up in disaster.
On the other hand, if Centrica’s does hit City targets for growth, then shareholders could be well rewarded. Based on current estimates, the stock is trading at a forward P/E of 7.4, that’s compared to the utility industry average of 15.
So, if Centrica hits the 9.4p per share earnings target the City is currently forecasting, a multiple of 15 times on this figure could give a potential share price of 141p, 100% above current levels. Add in the stock’s current dividend yield of 7.3%, and the return could be even higher.
Risk vs reward
I think the chances of Centrica hitting next year’s earnings forecasts are less than 50/50. The odds seem to be stacked against the business.
The problem is, so much of the company’s operations are just outside of management’s control. Things like energy prices and other operating costs. There’s also the wave of new competitors that have entered the industry recently, and are undercutting British Gas.
Centrica is taking action to try and restore confidence in the business and the brand, but there’s no guarantee these efforts will pay off. And it’ll take some time before cost-cutting efforts really start to show through on the bottom line.
So overall, while there’s still a chance Centrica will be able to return to growth next year, I think it’s much more likely the company will continue to struggle. If earnings are downgraded once again, the share price could continue to fall.
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Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.