Centrica plc is an integrated energy company and has a market cap of £10.73 Billion. The Company operates through three segments namely International Downstream, International Upstream and Centrica Storage. Out of all the segments, the company generates 85% of its revenue from the international downstream segment. This segment provides residential energy supply, residential services, and business energy supply and services in the United Kingdom, North America and the Republic of Ireland. The International Downstream segment consists of the operations of British Gas, Direct Energy and Board Gas Energy.
However, 2014 has been a challenging year for Centrica PLC because of the extreme weather conditions in the UK and US, volatile commodity prices and the falling oil prices. Despite the roadblocks, Centrica PLC reported solid second quarter results. Though oil prices are still a matter of concern for centrica PLC, the company bounced back with the solid second quarter results, indicating towards decent 2015 results. Also, to strengthen its foothold in the challenging markets, the company is planning to pursue inorganic activities and plans to acquire Norwegian continental shelf as the company sees Norway as its main growth area for new production.
The company’s adjusted earnings were up by 15% in the second quarter 2015, compared to a year ago. Also, the company reported a strong balance sheet and financial metrics in H1’15. Centrica PLC reported cash inflow of £357 million in H1 2015 compared to the cash outflow of £ (59) million in H1 2014.
Please find below a snapshot of the company’s cash flows from the company’s investor presentation:
(Source: Investor presentation)
We would also like to mention that the company had a gearing ratio of 207% in the year 2014, which puts a question mark on the financial stability of the company. However, the good news for the investors here is that the company’s net debt too reduced by 6% to £4.905 billion in June 2015 compared to £5.196 billion in December 2014, which would bring down the gearing ratio in the coming fiscal year.
Earnings outlook and valuation:
According to the management guidance, the competitive business environment will continue and falling commodity prices would be a matter of concern. Also, as per the latest H2’15 results, company’s full year adjusted basic EPS is expected to be in line with the first half of the year which indicates positive net earnings in 2015 in contrast to the negative earnings in 2014.
Based on the above discussion, the management guidance and our own estimates, we estimate Centrica's 2015 revenue will be £30.878 billion (£29.408 billion for fiscal 2014) and the operating profit will be £1.235 billion (2014 operating loss was £-1.137 billion). Our estimates are conservative and assume 5 % year-over-year growth in sales and a margin for earnings before interest and taxes (EBIT) of 4%. Please find below the table showing these estimates:
The company’s profits fell in 2014 mainly due to a lower consumption, lower market prices and lower oil and gas prices. However, the operating profits were in red in 2014 because of the exceptional and non-recurring impairment cost of £1938 million.
Valuation based on Enterprise value:
We have assumed a conservative EV/sales multiple of 0.65, which is below the historical multiple of 0.70. Based on this ratio and estimated 2015 revenue, we have calculated a stock price target of £284.
The calculations are shown in the table below:
The figures above are in £ million, except the target price.
If we evaluate the above table, the valuation multiples like P/E, P/BV, P/S and EV/Sales for the forecasted years are clearly indicating that currently Centrica PLC is undervalued as these valuation multiples indicate how inexpensive is the company compared to its peers. Based on the current share price of the company, we can clearly see a drop in the multiples as well. Also, ROE and ROI seem to be bouncing back in the forecasted years, offering an attractive and lucrative return to the investors. Another impressive thing we found is the stable dividend yield of 4.9% in 2013 and 2014 respectively. As per the consensus estimates, it is expected that this will continue in the coming fiscal years as well.
Based on the above discussion and the fundamental analysis, we set a BUY recommendation on Centrica PLC with 6m-12m target price of £284.