How Will Centrica Plc Fare In 2014?

For most shares in the FTSE 100, 2013 was a good year and investors have likely enjoyed capital gains and rising dividend income.

That makes me nervous about investing for 2014 and beyond, and I’m going to work hard to adhere to the first tenet of money management: preserve capital.

To help me avoid losses whilst pursuing gains, I’m examining companies from three important angles:

1. Prospects
2. Risks
3. Valuation

Today, I’m looking at integrated gas and electricity company Centrica (LSE: CNA) (NASDAQOTH: CPYYY.US).

Track record

With the shares at 345p, Centrica’s market cap. is £17,529 million.

This table summarises the firm’s recent financial record:

1. Prospects

In a recent three-quarter management statement Centrica reckons it is securing new sources of gas despite challenging market conditions in both the UK and the US.  Conditions are also difficult for the firm’s gas-fired power generation and gas storage businesses in the UK and Centrica expects a flat earnings result for 2013 as long as extreme events relating to weather, commodity prices and asset performance don’t muck things up in the meantime.

Like other energy utility providers, profitability in Centrica’s domestic supply service balances precariously between red and black ink. Differences in demand due to unseasonably mild or extra cold weather, and variations in wholesale prices for energy, can tip the result with ease. However, Centrica derives profits from both upstream and downstream operations in roughly equal proportions, with around 71% of revenue coming from the UK, 24% from North America and 5% from the rest of the world.

Those finely balanced downstream operations supply both gas and electricity, under the British Gas brand in Britain and as Direct Energy in the US. Upstream operations, bearing the Centrica brand, include oil and gas exploration, production and storage activities; owning and operating combined cycle gas turbine (CCGT) electricity-generating power stations; offshore wind generating operations; and a 20% stake in EDF Energy’s UK nuclear power stations. So there’s good diversity here.

We’ll see how 2013 panned out when the full-year results are published on 20th February.

2. Risks

Centrica reckons that the UK energy sector is facing unprecedented public and political debate over rising bills just as the costs of securing and supplying energy are increasing, thanks to higher wholesale commodity prices, rising charges for transporting energy, and increasing environmental, social and compliance obligations.

The squeeze on household incomes seems to be moving upline to squeeze energy suppliers’ ability to trade profitably, which the firm says is influencing confidence. That’s all making it harder for firms like Centrica to invest in energy infrastructure, and the company reckons energy suppliers and politicians should help to minimise the effect of higher costs on bills and improve transparency to restore trust in the industry.  That seems like a good idea. But when regulators and public opinion beat down on an industry it can go on for years, as has been the case with banking.

One outcome seems to be a depressed Centrica share price. Whether that presents investors with an opportunity to buy better value remains to be seen.

3. Valuation

The forward dividend yield is running at around 5.2% for 2014 and city analysts expect forward earnings to cover the dividend about 1.5 times.

You can buy into that income stream for a forward P/E multiple of about 12.5, which looks full compared to earnings-growth expectations of 3%.

What now?

I like the diversified Centrica business model and the way it carries a lower debt-burden than many utility companies. However, there’s potential for the share price to go lower this year in my view so I’m staying away despite the alluring dividend.