LONDON — Successful investors use a disciplined approach to picking stocks, and checklists can be a great way to make sure you’ve covered all the bases.
In this series I’m subjecting companies to scrutiny under five headings: prospects, performance, management, safety and valuation. How does Centrica PLC (LON:CNA) measure up?
Centrica’s U.K. downstream electricity and gas distribution business, and its U.K. upstream gas production and electricity generation operations, are roughly equal contributors to profit. North America adds around 12%.
Production and generation act as a hedge to downstream activities as wholesale and retail margins tend to move in opposite directions.
Downstream, Centrica PLC (LON:CNA) inherited a dominant market position from the state-owned British Gas. As switching suppliers has become easier, competition based on price and service has intensified.
Upstream, the portfolio includes gas fields, 70% of the U.K.’s gas storage facilities, a fleet of gas-powered generators, and nuclear and wind interests. This segment’s prospects depend on the U.K.’s uncertain energy policy, but this could include a new “dash for gas“.
The multiple factors that impact Centrica PLC (LON:CNA)’s performance make for a bumpy ride. Though revenues have tracked upwards over the past eight years, operating profit has risen and fallen in the range of £130 million to £3.1 billion. Return on capital has varied from 12% to 46%.
However, the security of the company’s utility-like status means management has been able to pay a progressively rising dividend, flexing dividend cover between 0.3 times and 3 times.
Boss Sam Laidlaw’s background in the oil industry has aided Centrica PLC (LON:CNA)’s upstream development over his six years at the top. The executive-dominated board will miss Sir Roger Carr in the chairman’s seat if he moves to BAE Systems plc (LON:BA).
Substantial shareholdings among the directors are to be lauded.
Centrica’s net gearing of 70% is reasonable and the debt is mainly long term. Despite lots of real assets, tangible net asset cover is negligible.
Some £3 billion of cash flow easily covers fixed costs of interest, tax, and dividends. Upstream capex is a variable cash outflow, with 2012’s £2 billion funded by borrowing. More is anticipated this year, but the decision not to invest in new nuclear assets has allowed management to start a £500 million share buy-back.