Regular readers might have noticed that I’ve owned Centrica (LSE: CNA) shares for a long time. Too long, if I’m honest. The average share price of my Centrica stock is much higher than the stock’s current price, which means I’m sitting on a big paper loss.
The group published its 2020 accounts last week, giving me a chance to review my investment. Should I keep the faith, or is it time to cut my losses?
Change is happening
Things are changing at Centrica, which owns British Gas. New boss Chris O’Shea is simplifying the business. He’s already engineered a big reduction in debt, thanks to the £2.8bn sale of the Direct Energy business in the US.
However, this deal didn’t stop the group’s profits falling sharply last year. Excluding operations the company has sold, the group’s adjusted earnings fell by 35% to just 2.8p per share.
The dividend remains suspended and Centrica’s pension deficit of £1.9bn could yet require extra funding.
The only really good news from 2020 was that net debt fell by £0.4bn to £2.8bn, thanks to tight control on spending and continued job cuts.
At a share price of 53p, last week’s results value Centrica stock at 19 times 2020 earnings. This strong multiple suggests to me that the market is pricing in a recovery from 2021 onwards.
What’s the plan?
Centrica has sold its US utility business and plans to sell its UK oil and gas business, Spirit Energy. The group’s UK nuclear power stations were also up for sale, but these are suffering technical problems and the sale process is currently paused.
I expect Spirit Energy to be sold in 2021, as the oil and gas market recovers from last year’s crash.
This will leave the British Gas business at the core of the group, selling energy and services to household and business customers. Services are seen as a big area of growth, as they generate higher profit margins than electricity and gas.
The firm’s results seem to support this view. In 2020, British Gas’s services business generated twice as much free cash flow as its energy supply operation.
Alongside British Gas, Centrica is also involved in energy trading and providing energy solutions for larger corporate customers. The group also has a utility business in Ireland.
These four divisions will support Centrica’s new strategy of focusing on services and energy retail, rather than being a generator.
Centrica share price: my decision
Centrica still faces some difficult times. Leaving business issues aside, the company needs to make British Gas a well-loved brand. I’m not sure that’s true at the moment.
However, the business still satisfies my core requirement for holding — it generates plenty of cash. In fact, underlying free cash flow actually increased last year, from £472m to £685m. Based on today’s Centrica share price of 53p, this values the business at just 4.5 times free cash flow. That’s well below the market average and looks cheap to me.
I think Centrica still has some real problems, but I also think that events in 2020 provided O’Shea with the ideal opportunity to get all the bad news out of the way.
From now on, I expect a more positive tone. Based on the group’s strong cash flow and modest valuation, I’ve decided to continue holding my Centrica shares and await further progress.
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Roland Head owns shares of Centrica. 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.