The freak spike in energy prices has jump-started Centrica’s bottom line, after years of anaemic returns. Now the British Gas owner is attempting to convince investors it can use windfall profits to prepare the ground for more sustainable cashflows once markets cool
The plan? Invest between £600 million and £800 million annually in projects aimed at boosting energy security and renewable generation over the next five years. Those include battery storage and gas peaking plans, which run at times of high demand.
These are assets quicker to build than big-ticket infrastructure projects like a revamp of its Rough gas storage site, but the type that are capable of generating cashflows for 15 years-plus once in operation. Note that capex budget excludes the redevelopment of its Rough site and the Morecambe Bay gas field, where government support is a condition on pressing the button, Chris O’ Shea, the Centrica boss, has said.
It’s made possible by the whacking £1.3 billion in net cash sitting on the balance sheet, a product of profits banked after the surge in energy prices, a sharp contrast to net debt of almost £4 billion three years ago.
Given the painful history, investors understandably remain wary. An enterprise value of just under three times forecast earnings before interest, taxes and other charges is towards the bottom end of the post-price cap era.
Red hot power prices won’t last. The FTSE 100 group has guided towards adjusted operating profit of £800 million from its retail supply and trading operations, compared with £1.4 billion in the first half of this year. That’s based on the latest Ofgem price cap level, which allows for a profit margin of 2.4 per cent, up from the previous 1.9 per cent. Fixed margins mean higher profits when energy prices rise.
Future profitability for British Gas ultimately depends on how the next price cap is designed. Strip out a £500 million reimbursement for a more punitive price cap in 2021 and last year, at a time when wholesale costs soared, and profits were still an elevated £469 million for the retail supply business, more than double the 2019 figure.
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But even on lower numbers, funding the additional investment in infrastructure stacks up. On a back of the envelope calculation, £800 million in operating profit adjusted for maintenance capex and depreciation of the assets could equate to around £700 million in cashflows from the retail and trading businesses annually, bang in the middle of Centrica’s capex guide.
That’s without the contribution from the upstream business, albeit more volatile income streams. It is also in the context of a plan to run down the cash position, to run with net debt of no more than one times adjusted earnings before interest, taxes and other charges.
Balancing that with Centrica’s other financial commitments should be easily manageable. The cost of decommissioning ageing assets and its pension deficit payments has reduced. This year the annual cash pension contributions will come in at about £150 million, with £200 million in decommissioning costs.
For shareholders, the deluge of cash generated over the first half, an underlying £1.4 billion, means more heading their way imminently. The share buyback programme has been extended by another £450 million and the interim dividend increased by a third to 1.33p a share. Analysts at Investec think that payment will total 3.8p a share, at a cash cost of £203 million. The payment should be covered several times over by adjusted earnings this year, against a target coverage ratio of two.
A more scrutinous tax regime is a perennial shadow, made darker by record profits from British Gas. Centrica is also reliant on fierce price wars not making a return. They’re unlikely to make a comeback, given the depleted number of suppliers now in the market.
That doesn’t mean they never will. But by circumstance rather than any great strategic design, Centrica has its capital allocation in order.ADVICE HoldWHY A stronger balance sheet and clearer capex plans could invite more optimism
Segro
Few stocks oscillate as sharply in response to inflation readings. The magnitude of the fall from grace suffered by Segro is a reflection of the puffed-up property valuations that warehouse landlords had reached when the cost of debt was at historic lows.
The slide in property valuations continued over the first half of the year, down 1.4 per cent, which drove down the net asset value by another 3 per cent. But that is against a more severe 11 per cent decline over the whole of last year. David Sleath, the warehouse landlord’s boss, reckons that if valuations are not at the bottom, they are approaching it. Financial markets agree that interest rates have not got much further to go. It makes the scale of the gap between the share price and the net asset value look harder to justify.
Analysts at Peel Hunt think that net asset value will end the year at 986p, down from 1,137p at the end of 2021 when markets were at peak froth, but regaining a sliver of ground against the same point last year. Shares in the FTSE 100 property group trade at a 22 per cent discount to that forecast net asset value.
True, estimated rental growth has slowed, at 3.7 per cent, down from 5.9 per cent over the same period last year, although that is not far off a medium-term target range of between 4 and 5 per cent.
How valuations are holding up matters more than usual. Segro wants to keep its debt levels steady, financing developments with the proceeds of asset disposals.
It has £1.7 billion in cash and available debt facilities and the cost for completing its committed developments and those where it is on site is £365 million. But an aversion to upping leverage is hardly surprising.
The average cost of debt almost doubled to 2.9 per cent, but isn’t expected to increase too much more. About 85 per cent of the debt is at fixed rates or has already triggered caps. Property valuations would need to fall by about 45 per cent from the level at the end of June to breach covenants.
Now what it needs is another cooler inflation reading, which could ignite more confidence in valuations.ADVICE BuyWHY The scale of the discount attached to the shares looks too steep