British Gas owner Centrica PLC (LON:CNA) looks set to reach the low end of cashflow targets but if anything else goes wrong, the dividend is clearly at risk, UBS said as it downgraded the stock.
UBS cuts its recommendation on Centrica to ‘neutral’ from ‘buy’ and lowered its target price to 135p from 165p, saying the latest trading update from the company shows conditions are “tougher than we thought”.
READ: British Gas owner Centrica expects energy price cap to hit 2019 earnings
In last month’s trading update, Centrica warned that it expects the government’s energy price cap that is set to take effect in January would hit earnings and cash flow in 2019.
For the 2018 financial year, the group expects adjusted earnings per share in 2018 to fall to 11.5p from 12.6p last year after dealing with operational issues in the oil and gas arm, outages in the nuclear business and tough competition in the energy supply market that led to the loss of customers.
UBS noted that large customer losses have continued at British Gas, production volumes are lower in oil and gas and commodity prices have been falling.
“All this puts pressure on the strategy, and we no longer see a skew of risks to the upside,” UBS said.
Four concerns regarding Centrica
The investment bank said it was concerned about four things: British Gas, which has lost two million customer accounts in two years; operating problems upstream; more outages in nuclear; and pressures in the US where competition is "intense".
“Overall, we think management can (just …) reach the low end of cashflow targets, but if anything else goes wrong the dividend (already a payout ratio of >100%) is clearly at risk.”
UBS anticipates British Gas customer losses will slow to 4% per year after capped tariffs are introduced next year but will not return to the “sleepy levels” of 1-2% per year.
If commodity prices recover and the US surprises positively, UBS said its fair value price could climb back to 165p.
Possible takeover bid for Centrica?
Another possibility is a takeover bid for Centrica, UBS said, after rumours of foreign interest in the firm emerged last year.
UBS questioned the company’s chief executive Iain Conn about the market speculation at the first half results in July.
Analyst Sam Arie had asked: “I think last year there was a story that Centrica could be a takeover target. I am sure you can’t comment on that in any detail, but I am interested in what your perspective is if you like on the industrial logic for that? Are you in the camp that says Centrica needs to be independent to be successful or do you feel that actually being part of a larger group could be an advantage to you given the investment opportunities you have in front of you?”
Conn replied: Thank you, Sam, for that low ball” but stressed that the company’s focus was on delivering its strategy.
He said it was not clear that it was necessarily of interest to Centrica shareholders to be part of another group and there would need to be some industrial logic.
Conn added: “I suppose we could be attractive to someone else, but I haven’t seen much sign of it.
“The question I get often is, is one of the oil majors going to buy us or is Amazon going to buy us, those are the most common ones I get. I don’t know how to think about that. Is that a complement? I don’t know, but having been in one of the oil majors they have differing views on how to extract value out of customers.”