Broker snap: Deutsche Bank cautious about margins at Centrica and SSE

2nd Dec 2013 09:42

Deutsche Bank has taken Centrica off its 'buy' list and retained a 'hold' recommendation for SSE, despite that the government's efforts over the weekend to address energy affordability.After the Labour party continued to attack the energy retailers and promised a price freeze if it wins the next general election in 2015, Prime Minister David Cameron has been forced to respond by launching an inquiry into retail competition, prices and profit, while proposing to cut 'green levies' on bills."Temporary relief on green costs would be welcome but group earnings growth for Centrica and SSE still requires higher prices in our view. We see further political battles over energy prices in the run up to the probable May 2015 UK general election," Deutsche Bank said.The bank also said that the green cost relief is unlikely to help things on the margin side for the two companies."With average retail margins on turnover of approximately 2.5% after tax over the last four years, the energy companies seemingly have a good defence against accusations of profiteering. However, Centrica and SSE, the largest two retailers, have enjoyed much higher margins than the industry average. Switching rates have halved while profits have grown, and few assets are employed in the downstream business, making returns on capital look high."Analysts said that a more realistic forecast for sustainable retail profit margins is 3%, compared with its previous 6% estimate, "in a world of increased political scrutiny and little public sympathy". As such, earnings per share forecasts for both Centrica and SSE have been cut by 20% by 2016. The target price for Centrica has been reduced from 430p to 315p, while SSE's target has been cut from 1,400p to 1,280p. "Dividends look covered but group earnings growth for both companies depends on higher retail prices in the face of political opposition," Deutsche Bank said.BC