Centrica: Undervalued and High Yielding

Centrica is a four star stock according to Morningstar analysts, meaning the energy provider is undervalued - all while paying a 4.67% yield

Charles Fishman 21 November, 2013 | 8:38AM
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Centrica (CNA) has achieved steady earnings and dividend growth despite reduced retail gas and power demand and a large tax increase on North Sea gas production. The solid financial performance during tough macroeconomic times was due to its strategy of hedging roughly 50% of its retail energy sales with its own assets. However, owing to the declining production in the aging Morecambe gas fields,  Centrica has made several acquisitions of gas properties and increased its exploration to maintain this effective hedge level.

The key to continued earnings and dividend growth will be the amount of oil and gas Centrica produces from these acquisitions and the success of its exploration programs. Both create risk for investors. Still, we believe the company's strong balance sheet and diverse earnings can support its attractive dividend.

Centrica is also betting on the success of its retail strategy in the U.S. The mid-2013 acquisition of Hess’ energy marketing business makes Centrica the largest business gas supplier on the East Coast and the second-largest business power supplier in the U.S. Whether this integration along the retail energy chain can create a moat (competitive advantage) remains to be seen.

If natural gas prices rise from current levels, Centrica's new investments in natural gas production should result in strong earnings growth.

Centrica's 270 MW Lincs offshore wind farm and the company's large development pipeline of offshore wind projects position the company well in case the U.K. government elects to pursue offshore wind for reducing carbon from power generation.

The British Gas brand name has contributed to strong growth in the residential HVAC maintenance and heating system installation businesses.

But retail energy prices have risen significantly the past few years, and political pressure to keep prices low for homeowners is a headwind for earnings growth in the retail energy business. The increase in the supplementary corporation tax on North Sea gas production also puts an additional burden on Centrica's ability to grow earnings and hedge its retail natural gas sales.

 

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Centrica PLC118.00 GBX0.60Rating

About Author

Charles Fishman  Morningstar Equity Analyst, Equity and Credit Analysis

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