Buying shares in a large company which seems to be going through a rocky patch is always a risk, as in some cases these companies never actually manage to recover, but if you do get it right it can be very lucrative and Covid appears to have helped to create some good opportunities. Energy provider, Centrica (CNA) has performed terribly over the past six or seven years and anybody who has held it as a long term investment during that period of time will be sat on a sizeable loss. Even prior to the arrival of Covid it was already in a downwards spiral with high levels of debt and falling profitability, but the virus accelerated that and even though the markets and many energy shares have recovered to some degree in recent months, Centrica is still trading closer to the lows with a share price of 44.8p...
It has bounced back around 20% in the past couple of weeks, but even that is nothing to get too excited about in the context of the valuations that it has previously traded at. Despite the problems it has been having I have been a buyer of late, having taken most of my holding at between 36p and 40p, as well as adding more at around 44p after the US elections. My main reason for doing so is that I can see good recovery potential as the demand for energy isn’t going to disappear, and if anything will increase over the coming years, and Centrica is already involved in helping to reduce carbon emissions as it continues to be the largest energy supplier in the UK – and still expanding, as seen by the recent acquisition of the Robin Hood Energy customer base (112,000 residential and 2,600 business customers) for an undisclosed sum. One concern I’ve always had has been the high level of debt, which at the last set of interim results was over £4.7 billion of longer term borrowings, including bank loans, and even allowing for its cash reserves of £1.6 billion and other assets, net debt was still running at nearly £2.8 billion. That was an improvement of around 18% on the £3.37 billion of net debt it had for the same period in 2019, but is still much too high in my opinion and was costing the company around £20 million per month to service it all (£129 million for the first six months of 2020). Those accounts also showed that the company made a sizeable operating loss of £135 million, but to put that into context the company also reported net exceptional charges of over £1 billion, including a £785 million write down on the value of its exploration and production, and power assets to reflect the low commodity prices during the first half of this year. But in terms of the debt concerns, the impending sale of Direct Energy to NRG Energy for $3.625 billion will go a long way towards strengthening the balance sheet and seems to be a decent price (a 7.9x multiple of EV to underlying adjusted EBITDA for 2019).
News on the final approval for that deal could come at any time and I will be interested to see if any of the proceeds are distributed to shareholders, given that there was no interim dividend this year or final one in 2019. It’s not something I would bank on though as it may be that it is all used to bolster the balance sheet, but ultimately even if that is the case it increases the chance to a return to a decent annual dividend yield here in the future. There will also be further disposals to come as well as Centrica focusses solely on its core markets and, although I would expect the company to wait for an improvement in the oil price and market, at some point it is also going to dispose of its 69% interest in Spirit Energy. Exactly how much it will get for that is hard to gauge and will depend on which other parties are interested in buying it, but I can easily see that being a few hundred million or more, based on the reserves of Spirit, plus the profitability of the business prior to this year. It also plans to dispose of its stake in UK nuclear power generation as well.
That will all go some way to strengthening the balance sheet, alongside the cost cutting and efficiency measures that it has already been putting in place to improve future profitability, but it is still too early to know for sure whether the company can really turn things around in a big way and make a decent recovery longer term. But from a market cap of circa £2.6 billion, and a share price of a little under 45p, I can see potential here as an investment, and once the Direct Energy sale is completed and the debt is reduced, alongside improving energy markets, I don’t see any good reason why this won’t at least bounce back to the 80-90p level it was trading at prior to the arrival of Covid, and quite possibly much higher in the coming years. So, for me, it is a buy and longer term hold, from which you could reap some very nice rewards if things go to plan.
Filed under: Centrica, Headlam Group, ITM Power, Nichols, URU Metals, TomWinnifrith.com
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