Whilst this company has had many a criticism levelled at it over the years, it’s on track to deliver substantial cost savings this year. What’s more, it’s the partner of choice for for national oil firms which own the rights to undeveloped resources around the world. That’s why Paul Hill thinks it looks like a good long-term buy:
Centrica (CNA), rated a BUY by ABN Amro
Last week, shares in British Gas owner Centrica jumped 4% following ABN Amro’s upgrade from hold to buy. ABN Amro reckons that if the firm bought British Energy (BE), there’s about 100p a share of extra value to be had, even if it pays a 40% premium for the nuclear power supplier. Although this type of speculation is probably wide of the mark, it does show the huge potential synergies in combining Centrica’s mainly downstream interests with an upstream power generator such as British Energy.
Centrica has 49% of the domestic gas market. That’s around ten million customers – more than 3.5 times as large as its nearest competitor. Size advantage is important because it creates substantial economies of scale. The group also runs 14 power stations in the UK, US and Belgium, invests in offshore wind farms and owns the Morecambe Bay gas field.
For years, British Gas has been criticised for its high charges, lacklustre service and heavy cost structure. Steadily, though, things have changed. More efficient systems have been introduced, prices cut and offices closed, with 2,250 back-office jobs off-shored to India. The board aims to deliver £200m of cost savings in 2007.
Meanwhile, in August, Centrica reported better than forecast first-half results (H1’07). For the full year, the City expects turnover and earnings per share of £16.3bn and 29.4p respectively – putting the shares on an undemanding p/e ratio of 12, with a 3.9% dividend yield.
The main risk for investors is the lumpiness of Centrica’s earnings stream; it sources about 80% of its gas needs from the volatile wholesale markets. Between 2003 and 2006 the group was hit by the rapid rise in gas prices and the residential business became loss-making. As such, chief executive Sam Laidlaw is seeking to reduce this dependency to 65% by buying upstream exploration and production (E&P) assets.
With this in mind, one of the major achievements in H1’07 was the cash inflow of £1.3bn, with net debt halving to £942m as at June 2007. This reduction in borrowing has given Centrica the fire-power to pick-up synergistic E&P sites. Since August it has spent nearly £300m buying gas reserves in Canada (£56.9m) and in the North Sea ($486.4m).
Furthermore its huge footprint of 30 million worldwide customers offers Centrica the chance to become a downstream partner of choice for national oil firms. These firms own the rights to the vast majority of the world’s undeveloped gas resources. In return for providing them with a reliable and substantial gas demand in both the UK and North America, Centrica hopes to obtain upstream interests and/or equity stakes in major fields.
With its up and downstream operations set to become more in balance, I believe the stock offers good value for the long-term investor. The next trading update is due on 14 December.
Recommendation: LONG-TERM BUY at 356p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments