How the mighty have fallen (Emily Gosden writes). Less than a decade ago, Centrica ranked among the 30 biggest companies in Britain, but after hitting more than £4 in September 2013, shares in the owner of British Gas have been on a downward trajectory. With the energy group buffeted by myriad challenges, those shares are worth barely tenth of their peak, closing at about 42½p yesterday. This month, Centrica was demoted to the FTSE 250.
A new team is in charge of reviving its fortunes. Chris O’Shea, who joined as finance chief less than two years ago, took over as chief executive in the spring after Iain Conn was finally ushered out by Scott Wheway, the new chairman. Other long-serving senior executives are set to go in a tough but much-needed refresh. The challenges facing the new team remain forbidding, however.
The core British Gas business has been losing customers for years to cut-price rivals. Seven million households remain, but profits have fallen sharply after the government’s energy price cap limited tariffs. The supplier must dramatically reduce its costs if it is to survive. Centrica has — belatedly — acknowledged this and aims to be the cheapest supplier in the market by 2022. That will require streamlining bureaucratic operations; 5,000 job cuts announced this month are brutal but necessary, though will come at a significant short-term restructuring cost.
Ultimately, British Gas will need also to switch to a cheaper, better IT platform. Plans revealed by The Times this week for Centrica to launch a no-frills supply brand using a third-party low-cost IT platform are a start. Established rivals are already promising low costs and frills to boot; British Gas will need to do the same. And increasing competition, including from oil majors moving into the power sector, will keep pressure on margins.
British Gas is facing further short-term challenges from the coronavirus pandemic. Covid-19 has reduced power demand among the company’s business customers, more than outweighing any increase from people working at home. The downturn is expected to lead to increased bad debt, too, especially among struggling small businesses. This all puts further strain on cashflow, fuelling worries over its credit rating. A downgrade would take Centrica to one step above junk, inflating its costs for trading energy.
Centrica cut its dividend last year for the second time in five years, then scrapped the final 2019 dividend in April to help to shore up its finances. It is unclear when or at what level payments may be resumed.
Asset sales could bolster its near-term cash position, but the nuclear and oil and gas businesses that it wants to offload look even less attractive after a crash in oil prices and with no resolution of safety issues that have kept several ageing reactors offline. Direct Energy, its North American supply business, may offer an easier sale.
Centrica believes that it could weather a temporary one-notch ratings downgrade in the near term, but it needs to get its balance sheet back to health. Even asset sales would deliver only a temporary boost: a sustainable recovery rests on turning British Gas into an efficient, future-facing supplier.
Tempus has been recommending avoiding Centrica shares since early 2017, when they were worth more than £2, and last reiterated that recommendation in February, when they were just over 70p. The shares are even cheaper now, but the case to buy them is still not compelling. Dividend prospects are uncertain and the road to reviving British Gas will not be easy. For now, the advice remains to avoid.
ADVICE Avoid
WHY New team faces uphill battle to revive fortunes
Warner Music Group
Depending on which side of the fence you are on, Spotify either saved the music industry or destroyed it (James Dean writes). Most artists hate the streaming service because it pays them a fraction of a penny each time one of their songs gets played. Big labels like Warner Music love it because it provides reliable income from their big-name pop acts, whose songs are streamed millions of times.
The fortunes of Warner, the third largest of the “Big Three” music groups, have been turned around in the past decade because of streaming services. Ten years ago, illegal downloading was all the rage and the Big Three were in crisis, but the streamers gradually pulled people away from piracy and the companies’ valuations grew. Last year, revenue from recorded music climbed by 8.2 per cent to $20.2 billion, figures from the International Federation of the Phonographic Industry show. Streaming accounted for more than half of the total for the first time.
Warner, based in Los Angeles, owns labels including Parlophone, Atlantic Records and Roadrunner Records and represents artists such as Ed Sheeran and Coldplay. It was listed on June 3 at $25 per share. Those shares were changing hands for almost $32 yesterday, a 28 per cent gain since the float, at a time when the S&P 500 has risen by less than 1 per cent.
For now, the success of Warner and its peers remains tied to that of Spotify and other streamers — more so than in the film and television industry, where the likes of Walt Disney have launched their own services to compete with Netflix.
However, the reversal of fortunes for the music groups gives them greater leverage over Spotify when it comes to licensing deals. They, too, could launch streaming services of their own. Aside from a smattering of podcasts, Spotify, unlike Netflix, does not create the content that it relies upon: the music labels do all that.
As such, Warner, valued yesterday at $16 billion, looks cheap when compared with Spotify, which is valued at $46 billion. Warner’s shares trade at about 3.5 times trailing sales, whereas the Swedish streamer’s are at 4.3 times. This makes Warner look attractive for a lengthy hold, even given the post-float bump.
ADVICE Buy
WHY Valuation has not caught up with streaming boom
