Why has Centrica’s share price halved in five years?

In recent years, Centrica has been struggling. On 23 November, a close-period trading update is due; it may be downbeat, says Nigel Hawkins, especially with the unseasonably mild weather of late.

It seems many years since Centrica was thriving, with a share price pumped up on misplaced rumours of interest from Russia’s Gazprom – a barely conceivable scenario today.

In the late 1990s, Centrica was demerged from British Gas which had been privatised in 1986. The exploration and production part of British Gas’ portfolio, BG, was acquired – controversially – by Shell in 2016, who arguably paid a very full price. The gas transportation division, Transco – the subject of an epic regulatory battle with Ofgas in the 1990s – was acquired in 2002 by National Grid.

Centrica’s plight is illustrated by its lacklustre share price performance. Over the last year, its shares have fallen by over 20 per cent; over five years, its shares have almost halved in value. Remember, too, that these share price declines have taken place against a strong FTSE-100 market, which recently achieved another record high.

The threat to Centrica’s dividend, which has already been cut sharply, lies behind its share price decline. Dividend cover remains low – in the 2016 full-year, it was 1.4x. Hence, paying out increasing dividends in the future may not be feasible unless there is marked improvement in financial returns.

The much-trailed energy price cap has hung heavily over Centrica’s market rating. Whilst it is unlikely to impact for at least a year – and may only be a temporary political expedient – it goes right to the heart of Centrica’s profit centre, its retail gas supply business. By imposing a maximum price, margins will surely be cut – by how much is debatable. Furthermore, the government seems determined to introduce a price cap that applies to many millions of gas consumers on standard variable tariffs.

“For some time, gas prices have been weak with demand for gas also being lower than anticipated.”

Politically, Centrica, like other UK utilities, is adversely impacted by a weak government, a resurgent Labour party – now level-pegging in the opinion polls – and the latter’s wide-ranging utility re-nationalisation pledges. Re-nationalisation on the Labour party’s terms – with the level of compensation for compulsory acquisition to be decided by Parliament – is a real downer for shareholders.

In the short-term, Centrica really would welcome a cold winter, boosting gas demand. Cold snaps at week-ends are particularly beneficial for Centrica’s finances. Instead, some weather experts are forecasting an Indian summer – bad news for Centrica’s shareholders.

In the medium term, a sustained recovery in gas prices would benefit Centrica, which still has substantial production assets in the North Sea – these are due to be transferred to the joint venture with Bayerngas Norge, in which Centrica will hold a 69 per cent stake. For some time, gas prices have been weak with demand for gas also being lower than anticipated.

Clearly, Centrica cannot simply wait for a sharp recovery in gas prices. A similar conundrum – though on a far larger scale – has confronted the oil majors, such as Shell and BP, in recent years. Given these various challenges, Centrica’s incoming chief executive, Iain Conn, presented a new strategy in 2015 – it was supplemented during this summer’s Capital Markets Day.

“Energy supply is going through many changes at present: Centrica is in pole position to benefit from these trends.”

At its core is the commitment to grow underlying adjusted operating cash flow by 3-5 per cent per year until 2020: the 2016 growth figure was an impressive 14 per cent. Central to Centrica’s new strategy has been down-sizing the role of E and P, which had been expanded under Conn’s predecessor, Sam Laidlaw. It is being increasingly recognised that the era of high – and sustained – oil prices is probably over.

Secondly, generation returns in recent years have been very disappointing, although a £75 million underlying operating profit from this segment was reported in 2016. Some large plants have now been sold, with renewable energy generation seemingly no longer on Centrica’s radar. Instead, Conn wishes Centrica “..to be at the centre of our customers’ daily lives”. Its role as a major energy services company enables it to be so.

However, there is considerable doubt as to whether its much-hyped Connected Home initiative can deliver the very ambitious financial returns that are being sought; in 2016, it reported an underlying operating loss of £50 million. To be sure, energy supply is going through many changes at present, with the advent of smart meters, sophisticated energy management techniques, electric vehicles and distributed generation inter alia: Centrica is in pole position to benefit from these trends.

Along with Centrica Consumer, Centrica Business is also seeking to re-establish itself. Whilst its UK business market is far less profitable than its UK retail equivalent, the split in the US operations is reversed. Clearly, with this quite fundamental re-booting of Centrica, investors will need considerable patience, although the depressed share price could be boosted by speculative activity.

In any event, the 23 November pre-close trading statement is unlikely to be overly bullish.