Energy minister, Ed Davey, may have hit on something when he suggested that Centrica's business model should be analysed - although perhaps not exactly what he thought. The company's business model, which in essence piles a gas exploration and production (E&P) business atop a utility may have less merit than one might think. Yes, it does help the firm hedge against rising gas prices. However, the business case from 'good' cash-flow generation is growing increasingly untenable.
That is because of taxes on North Sea oil and the fact that those cash flows no longer seem to be growing. Despite that, E&P absorbed £1.9bn in investment in the three years to 2012 and will get another £1.1bn in 2013 alone. Is there a valuation argument despite the flat-to-down cash flows then? No, rather the opposite is true. Thus Centrica's enterprise value-to-cash flow multiple, at around 5, is approximately half of those of its utility peers. Lastly, indeed, E&P's realised prices are not regulated, but Davey's comments underscore that attached to those comes 'political risk', says the Financial Times' Lex column.
'Anyone' coming into this reporting season might be expected to suffer disproportionately given how some companies' valuations are overly reliant on optimistic assumptions. Civil engineer Hyder Consulting is a case in point. Before Monday's profit warning markets were seeing no downside at all. Following elections in Australia authorities in that country are now more reliant on PFI-style financing initiatives, slowing the flow of orders for Hyder.
Then, of course, there is the 25% drop in the Australian dollar, versus sterling, to contend with. Lastly, the firm is facing slower orders in the Middle East, but cannot be very specific due to "commercial sensitivities". The shares
have since lost a quarter of their value and analysts trimmed their profit estimates for this year and next by approximately a fifth. Some observers believe the stock is overdue a bounce "but, frankly, that would seem to be taking optimism to extremes", writes The Times' Tempus.
The Energy Minister's warning that Centrica's British Gas subsidiary may need to be broken up may rob investors of one of their favourite havens. The firm's ability to produce energy resources while at the same time supplying domestic consumers has been key in allowing it to provide stable investment returns. Each of those units, on its own, tends to be quite volatile in terms of profitability; yet together they tend to compensate for each others' ups and downs.
In a recent research note analysts at Deutsche Bank told clients that Centrica is perhaps the most exposed of all the energy utilities to an investigation into market competition and prices. The company controls 43% of the market for supplying gas to households. To take into account as well, its foray into North America has yet to pan out. The Daily Telegraph's Questor downgraded the shared to 'hold' last November as they judged a recovery to be some ways off and that advice remains.
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