Morningstar | Centrica Reiterates Its FY Targets Despite a Persistingly Challenging Backdrop; Shares Undervalued
We reiterate our fair value estimate of GBX 140 per share along with our no-moat, stable trend ratings after Centrica released its trading statement for the first four months of 2019, in which it reaffirmed its 2019 targets and announced it will present a strategy update at its half-year results on 30 July 2019. After the credit rating downgrade in April by S&P from BBB+ to BBB, we think the largely factored-in dividend cut is highly likely. In addition, against a backdrop of declining interest rates, the upcoming pension triennial review implies a risk of an increasing pension deficit, break-even at year-end 2018. A decrease in the current discount rate from 3% to 2% would drive a GBP 700 million rise in the pension deficit before tax, implying a negative valuation impact of GBX 10 per share, according to our calculations. Altogether, the significant undervaluation of the shares offers a good safety margin.Centrica lost 20,000 accounts globally in its customer-facing divisions. Still, churn remained high in the U.K. retail business where the group lost 234,000 accounts, or 2% of its base, versus our 6.7% churn estimate for the full year. Notably, churn increased in March and April following Ofgem's announcement of an increase in the tariff cap. In the North American business division, its power margin improved although its gas margin was hit by warm weather. The improvement in its power margin is encouraging after two years of sluggish profitability. Spirit Energy's production was slightly ahead of expectations. Revenues of Distributed Energy & Power and Connected Home divisions jumped 58% and 70% respectively, accelerating versus 2018.
Despite a challenging business backdrop marked by warm weather, falling natural gas prices and extended outages at two nuclear plants, Centrica reiterated its 2019 guidance of adjusted operating cash flow in a GBP 1.8 billion to GBP 2 billion range and net debt in a GBP 3 billion to 3.5 billion range, in line with estimates.
Centrica is an energy and services company. Co.'s segment are: Energy Supply and Services, which supplies gas and electricity in the U.K. and North America; Connected Home, which supplies energy solutions and technologies to residential customers; Distributed Energy and Power, which supplies energy solutions, generation and technologies to commercial and industrial customers; Energy Marketing and Trading, which trades and optimizes energy; Exploration and Production, which produces and processes gas and oil and develops new fields; Central Power Generation, which generates power from combined cycle gas turbines, wind and nuclear assets; and Centrica Storage, gas storage in the U.K.
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