EUR 850.00 For Business Accounts Only

Morningstar | We Cut Centrica's FVE to GBX 100 and Anticipate a 50% Dividend Cut; Shares Fairly Valued. See Updated Analyst Note from 05 Jul 2019

We cut our fair value estimate from GBX 140 to GBX 100 per Centrica share on a 20% average annual cut in our adjusted EPS through 2023 and in anticipation of a GBP 1 billion increase in the pension deficit. We maintain our no moat, stable trend ratings. We expect the 2019 dividend to be cut by 50% to GBX 6 versus a 25% cut previously, because of a sharper fall in 2019 operating cash flow. Our new dividend involves a yield of 6.9%, above the sector average of 5%, but with much higher business risk. Shares appear fairly valued.

We cut our adjusted EPS by 20% on average through 2023, mainly on lower profitability estimates for supply in the United Kingdom. In 2019 we cut our EPS by 24% from GBX 8 to GBX 6, 30% below the consensus' GBX 9. The key driver is also lower U.K. supply profitability on higher churn and a drop in average gas consumption after warm weather in the first quarter. We expect profitability to partially recover on cost savings. We now project the tariff cap to be extended permanently versus a removal in 2023 under our previous assumptions, because we now we believe it will be politically difficult to justify the tariff cap removal.

We factor in a 50% cut in 2019 dividend to GBX 6 versus a 25% cut to GBX 9 for the consensus. Owing to a sharp fall in 2019 operating profit, we estimate the group will deliver adjusted operating cash flow of GBP 1.9 billion on average over 2018-2020, GBP 0.3 billion short of the middle of the GBP 2.1 billion-GBP 2.3 billion range needed to maintain the GBX 12 dividend per share. Accordingly, we factor in a 50% cut in the 2019 dividend cut to GBX 6, enabling the group to save EUR 0.35 billion of cash annually.

We project the pension deficit to increase by GBP 1 billion once the ongoing triennial pension review is completed because we expect the discount rate to be lowered from 3% to 2.5%, versus 2.65% for SSE and National Grid, against a backdrop of low interest rates. This shaves GBX 14 off our fair value estimate.

The continuing drilling campaign to appraise the commercial potential of the Lincoln discovery and the Warwick exploration prospect in West of Shetland implies significant valuation upside potential. According to Centrica, Lincoln and Warwick are estimated to hold 604 mmboe gross 2C contingent resources. Rystad estimates a net present value of USD 3.6 billion for the Lincoln field. Given the 50% stake of Spirit Energy in the field and 69% Centrica's stake in Spirit Energy, this points to potential value accretion of GBX 17 per share that we've included in our bull-case scenario. Because of the typical high uncertainty of appraisal campaigns, we have not included any likelihood of success in our base-case scenario.