Centrica plc (LON:CNA)’s investment case is being overshadowed by the UK government’s plans to introduce a cap on energy bills, according to Barclays.
The Conservatives have proposed a price cap on standard variable tariffs (SVT), cutting £100 off the average household bill.
“If the SVT cap methodology fairly reflects genuine long-run efficient costs, we expect an efficient Big 6 retailer to be able to earn a c.2.5-3.0% EBIT (underlying earnings) margin under such a cap, leaving two main questions: 1) will the cap be constructed fairly, and 2) how many customers will be impacted,” Barclays said in a note on utilities.
“We see significant valuation risk for Centrica to both the up and downside depending on the outcome to these questions; and with the stock broadly reflecting a likely fair balance of these risks, we thus remain ‘equal weight’ for now.”
Shares in Centrica rose 1.41% to 201.60p as Barclays lifted its target price to 215p from 195p and said the group has strong cash generation. At its full year results in February, Centrica reported a 14% increase in operating cash flow and said it expects growth of at least 3-5% per year on average through 2020.
Barclays said much will depend on whether the outcome of the general election causes disruption to the Tory’s plans for an energy price cap. Theresa May’s Conservatives were forced to partner with Northern Ireland’s Democratic Unionist Party to form a government after they failed to secure a majority in Friday’s general election.
Drax shares lifted as Barclays hikes target price...
Drax Group plc (LON:DRX) shares also received a boost as Barclays reiterated an ‘overweight’ rating and raised its target price to 420p from 410p.
The company, which owns the UK’s largest power plant, saw its shares jump at the end of 2016 after the European Commission approved a contract for difference investment awarded by the UK government for Drax’s third unit to run on biomass instead of coal.
However, the stock fell sharply in mid-February after the company announced plans to overhaul its dividend policy to protect itself from volatility in the wholesale energy market.
“We believe the scale of this fall was totally unjustified, especially as wholesale energy prices over the interim period have been relatively stable and other newsflow (Ofgem proposed changes to embedded benefits, a value accretive acquisition, and improving renewable obligation certificate auction prices) have been positive,” Barclays said.
“Whilst the stock has recovered just over half its fall, we still see it as significantly undervalued.”
Barclays expects free cash flow will total around 1.8 times current market capitalisation by the end of biomass subsidies in 2027. This will leave the company with just under £1.2bn of net cash, in addition to the nearly £900mln of cumulative dividends expected under its current dividend policy. Barclays said Drax will have more than £2bn of capital to commit to a “significantly more generous dividend policy and value accretive acquisitions”.