Value investing legends such as Howard Marks argue that to be successful in the market, it’s not so much about what you buy as the price you pay for it. Put another way, shares in an under-performing company can still make you a lot of money if you acquire them below their fair value.
With this in mind, is it possible to double your capital with a stock like battered energy giant and FTSE 100 member Centrica (LSE: CNA)? Here’s my take.
Losing its crown
As anyone with a casual interest in Centrica will know, the owner of British Gas isn’t devoid of problems. Arguably the biggest faced by the business right now is its dwindling customer base. Indeed, an increasing number of nimbler competitors and the ease at which people can now switch suppliers has led the market leader to haemorrhage around 2m members over the last four years.
Given the Labour party has made no secret of its desire to re-nationalise energy suppliers, if elected, another concern for Centrica in recent times has been the prospect of a Labour government. Whether you believe Jeremy Corbyn could ever make it into Number 10 or not, the mere possibility — combined with the current Government’s cap on energy prices — demonstrates how exposed the company is to political interference.
All this before we’ve touched on the fact that Centrica has been (and will continue to be) impacted by things it can’t control, namely commodity prices and the weather. Oh, and it’s also shortly to become rudderless with CEO Iain Conn stepping down next year.
No wonder it’s cheap!
Having halved in value in just 12 months, Centrica’s stock is left trading at a little under 11 times forecast earnings. If we momentarily assume the share price doesn’t budge, this falls to under 8 times in FY20, based on analyst assumptions that earnings will bounce back to form. This suggests the stock could be a bargain, relative to both the wider market and peers.
Unfortunately, it’s not that simple. For the £4.2bn-cap to double in value from here, there needs to be a catalyst for it to dramatically improve its popularity with consumers and recruit a strong CEO while keeping the dividend at a reasonable-but-still-attractive level. That’s quite a challenge.
On the first point, the best existing investors can hope for at the moment is that the outflow of customers is halted. We’ll see whether it’s managing to do this when it reports on Q3 trading next month. Good news will see the share price soar, but I’m not holding my breath.
Finding someone to take on the poisoned chalice of leading the company could also be difficult, particularly given the criticism, however justified, handed out to the departing Conn by the media and shareholders.
And then there’s the dividend. Despite being sliced, the total payout this year is expected to be 5.1p per share, which still equates to a yield of almost 7%. With cash returns covered only 1.4 times profits, I wouldn’t rule out another cut — and investor exodus — if the company misses earnings estimates.
In sum, doubling your money through Centrica is not beyond the realms of possibility, but it will surely require the mother of all recoveries. Why take the risk when you can make good money elsewhere in the market at far lower risk?
Paul Summers 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.