You might barely give it a cursory thought, just like those disclaimer’s on your broker’s website that warn your investments can go down as well as up. But political risk, whether you choose to ignore it or otherwise, can severely impact certain holdings. Both those warnings should be heeded.
Shares in British Gas owner Centrica (LSE: CNA) are down a little over 2% this year, and while a potential price freeze might amount to political hot air, it seems unlikely — the opposite being Ed Miliband’s pledge to break up the big British banks, which the sector shrugged off.
We’ll look at the strength of Centrica’s underlying business, and assess the long-term prospects for investors.
The risk
So, first off, a basic overview of the political risk.
If Labour wins the next election then energy companies could be prevented from raising household bills. The implications for Centrica would be severe, given that higher costs, in addition to deserting customers, saw profits at British Gas decline to £571m from £606m a year earlier.
Latterly, the regulator Ofgem has deemed it necessary for a Competition and Markets Authority investigation, potentially leading to a breakup of the “Big Six” energy firms. Profits at the energy suppliers shot up to £1.1bn in 2012 from £223m in 2009, according to Ofgem, which believes “competition is not working as well as it could”.
SSE, Centrica’s rival, took note and promised to freeze prices for customers until 2016. It was hardly out of altruism, however, given the firm will slash 500 jobs as part of a cost cutting drive, putting shareholder interests front and centre. Indeed the shares actually added 23p on the news.
The business
Centrica controls 43% of the home gas supply market — almost three times SSE (15%) — therefore it’s the most obvious target of an investigation into pricing and competition.
Analysts forecast that Centrica’s earnings per share (EPS) will fall by 29% to 27.3p next year. Dividend cover is projected to slip to 1.5 times earnings for 2014 and 2015.
There’s little solace to be take from overseas performance, either. Take the downstream business in North America. Profits at Direct Energy, the Canadian service provider Centrica bought in 2000, decreased by 11% to £276m in 2013.
Problems included rising wholesale costs and a competitive market environment, leading to squeezed margins and falling customers. Sam Laidlaw, Centrica’s chief executive, had aimed to double Direct Energy’s profits within five years, through a string of asset purchases.
Laidlaw, who is preparing an exit from the company, won’t be around to see this through. After eight years, he’s leaving for a fresh challenge. That leaves us with the question: should you get out, too?
A buying opportunity?
While Centrica’s shares are trading at a discount, they aren’t cheap enough in my mind to constitute a ‘buy’. There are better blue-chip options elsewhere in the market, trading at cheaper prices, albeit for even less of a reason and with more potential upside than Centrica.
