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The Centrica share price is dirt-cheap: here’s what I’d do now

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The Centrica (LSE: CNA) share price has fallen by 55% this year. Thanks to the stock market crash, this utility stock has now lost 90% of its value since September 2013. This humbling collapse was capped last week when Centrica was demoted from the FTSE 100 to the FTSE 250.

There’s clearly some risk that Centrica has become a value trap — a stock that’s cheap for good reason. However, I don’t think this is true. As I’ll explain, I believe Centrica faces temporary problems that can be fixed. After this, I expect it to become a much more valuable business.

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Market leader

Centrica’s main UK business is British Gas. This division supplies gas, electricity and home services, such as boiler maintenance and repairs. There’s also a smaller home solutions business in the UK, which sells connected home products, under brands such as Hive.

Centrica’s battered share price makes it easy to forget how dominant British Gas still is. At the end of 2019, this business had 9.2m customers in the UK, each taking an average of two services.

This means around one-in-seven of the UK population are British Gas customers. Based on the average UK household size of two people, this suggests it supplies around one quarter of UK households.

This puts British Gas on a level with heavyweight consumer brands such as Tesco and Next — companies that everyone knows and many of us use.

Why I think the Centrica share price is too cheap

Led by British Gas, Centrica’s consumer businesses generated an adjusted operating profit of £505m in 2019. Alongside this, the group’s business division made a profit of £217m. This gives a total operating profit from energy supply and related services of £722m.

This gives the group an earnings yield — a measure of profit used by business buyers — of more than 10%. I usually look for an earnings yield of at least 8%, so the Centrica share price looks cheap to me on this measure.

Unfortunately, this isn’t the whole story. Centrica has a couple of problems. The first is its upstream division. This includes an oil and gas production business, plus part-ownership of the Hunterston B and Dungeness B nuclear power stations.

These operations are up for sale, but this year’s market crash has delayed this process. However, I’m confident a deal will be done eventually. This should allow the group to cut its debt levels and become a consumer business with less exposure to volatile commodity prices. I think that could push Centrica shares much higher.

This competitor trades on 30x earnings

Centrica’s share price of  around 40p means the stock currently trades on just nine times 2020 forecast earnings. This figure falls to just 6.4 for 2021. The shares probably deserve to be cheap at the moment, but I don’t expect this to last forever.

I think investors should look at home repair specialist Homeserve to see what could be achieved with the British Gas brand. Homeserve only supplies services, not energy. Its profits have doubled in five years and Homeserve shares currently trade on 30 times forecast earnings.

In my view, British Gas’ growing services business is well positioned to take a big slice of this market. That’s why I rate Centrica as a bargain buy at current levels.

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Roland Head owns shares of Centrica. The Motley Fool UK owns shares of Next. The Motley Fool UK has recommended Homeserve and Tesco. 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.

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