Centrica’s windfall profits are not the result of any brilliant strategic manoeuvres but the freak surge in energy prices. Adjusted operating profits for last year jumped to a record £3.3 billion, more than three times the level in 2021 and ahead of even the market’s bullish expectations. Pretty much all of that came from energy trading, its North Sea oil and gas production, and a 20 per cent stake in Britain’s nuclear power plants.
For shareholders, the deluge of cash generated by these businesses means more heading their way imminently. Another £350 million in share buybacks are planned, on top of the £250 million announced in November. That is on top of the 3p-a-share dividend declared for last year, a payment reinstated in July.
And yet, finding redemption in the eyes of investors continues to be a struggle. An enterprise value of just 2.2 times forecast earnings before interest, taxes and other charges is about the lowest in at least a decade. Why? Because energy is a highly cyclical industry; soaring commodity prices will recede eventually. Centrica has locked in the bulk of its nuclear and gas output for this year at higher prices than the hedges that are currently rolling off, according to Jefferies estimates. Roughly 23 per cent of the former has been forward-sold for next year and 57 per cent of gas, it reckons.
But income from the upstream business and the exploitation of oscillating energy prices will abate. Analysts have forecast an adjusted operating profit of £2.74 billion for this year and another decline to £2 billion the next as commodities prices come back down. That will bring the retail supply business back into sharper focus. Fierce price wars with smaller players undercutting the likes of British Gas have come to an unceremonious halt in the face of rampant wholesale prices, which at least gives the supply business a better chance of actually retaining its customers — something that has proven problematic in recent years.
However, generating a consistent profit from both the British and the Irish supply businesses has been fundamentally challenging for some time. Last year British Gas generated an adjusted operating profit of £72 million, which translated into a margin of 0.5 per cent. Amid calmer energy markets? The adjusted margin was still only about 3 per cent for its UK consumer business.
True, plentiful cash churned out over the past two years has also substantially strengthened the balance sheet. A net debt position of almost £4 billion three years ago has become a £1.2 billion net cash pile. More broadly, Centrica’s financial liabilities have reduced over the past five years. The cost of decommissioning ageing assets and its pension deficit payments have reduced in recent years. But it is still unclear where Centrica plans to deploy its cash, with a previously trailed £3 billion capital expenditure budget not yet confirmed, or allocated. Investors will have to wait until July to get more clarity on that.
Investors in Centrica cannot ignore the spectre of regulatory change. Bumper profits amid a cost of living crisis will only help to focus the chancellor’s mind on calls for a windfall tax on energy groups. Then there is the fallout from the recent investigation by The Times, which revealed that contractors working for British Gas were breaking in to the homes of vulnerable customers to install prepayment meters. Ofgem is currently investigating the supplier over the revelations.
There are purer ways to win for investors who want to bet that commodity prices stay higher for longer. Take Shell or BP: neither can ignore the threat of harsher windfall taxes, but what they do have is far clearer capital allocation plans.
ADVICE Avoid
WHY Profits from volatile commodity prices won’t last and the retail supply business remains challenged
Relx
Amid the macroeconomic tumult, investors have flocked to defensive plays like Relx. The shares trade at almost 22 times forward earnings, characteristic of the premium investors have been willing to pay for the reliability of subscription revenues.
The FTSE 100 group is attempting to shift towards selling more sophisticated data and analytics tools alongside its traditional subscription-based research materials in the hope of accelerating the pedestrian rates of organic growth that have historically been eked out by the publishing giant.
The evolution is paying off. Organic revenue rose 9 per cent last year, more than double a pre-pandemic growth rate of 4 per cent. The improvement still stands, even after stripping out the impact of a bounceback in events as global lockdowns come to an end.
The aim is to boost the rate of underlying gains made by scientific, technical and medical and legal divisions — historically between 1 per cent and 2 per cent — closer to those of the risk business, typically between 7 per cent and 8 per cent annually. Last year the former posted gains of 4 per cent and 5 per cent, respectively. But there is plenty of scope to push close that gap.
Roughly 70 per cent to 80 per cent of revenue generated by the risk business, which caters to industries such as insurance and auditing, comes via this more lucrative source, but that proportion is currently only 20 per cent to 30 per cent for legal and scientific, technical and medical.
The question mark hanging over the recovery in events, which produced 16 per cent of revenue pre-pandemic, is also fading. That business is slated to be back at 2019 profit margins by the end of the year.
Leverage is at the bottom end of the historic range, at 2.1 times adjusted earnings. Being light in capital intensity and highly cash-generative has resulted in a record of returning cash via buybacks. Another £800 million in share buybacks is planned for this year.
Against an average price/earnings ratio of 19, Relx’s current valuation is not unremarkable. If it can continue to push organic growth rates forward, it could deserve an even richer valuation.
ADVICE Buy
WHY Higher rating deserved with growth accelerating
