Over the past 12 months, shares in British Gas owner Centrica (LSE: CNA) have struggled. The shares have lost 29% of their value compared to the FTSE 100, which has gained 4% over the same period. Both of these figures exclude dividends.
The questions I’m seeking to answer here are, what’s behind this and will Centrica continue to underperform?
The UK’s most hated company?
In my view, there are three factors that are currently holding it back. First off, earnings are under threat from the government’s proposed energy price cap. Analysts believe that this regulation could be in place by the end of 2018, limiting the fees on the standard variable tariffs used by 11m homes across the UK, an essential profit pool for the company.
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At the same time, Centrica is facing a customer exodus. The UK’s largest energy supplier has been haemorrhaging customers as competitors have ramped up their assault on its dominant market position and try to capitalise on its weakness. Between July and October last year, the firm lost 823,000 customers and it lost another 110,000 domestic customers during the first quarter.
And finally, in the background, there’s the possible threat of nationalisation if the Labour party gets into power.
Management has been trying to offset declining customer numbers and the impact from the looming price cut by slashing costs. Centrica remains on target to cut expenses by £200m this year as part of a £1.3bn efficiency drive.
But cost-cutting can only go so far, and it’s not a magic solution to all of its woes. Indeed, if management cuts too deeply, customers will notice the deteriorating service, which may only accelerate the exodus.
What does the future hold?
Unfortunately, City analysts don’t see the company’s fortunes improving any time soon.
A recent research report from analysts at investment bank Morgan Stanley noted that in past examples, (most notably the gambling industry) increased industry regulation usually results in more, not less competition, implying the firm’s customer exodus could get a lot worse following the energy price cap introduction. The bank believes Centrica’s earnings are going to decline steadily from next year onwards as the price cap and falling customer numbers weigh on the group.
This is just one view, but it seems to align with the consensus. Overall, the City is expecting a 5.4% decline in earnings per share for 2019, following a marginal bounce of 6.6% to 13.6p for 2018.
If these predictions turn out to be correct, it looks as if the company’s dividend is under threat as well.
At present, the distribution is only covered 1.1 times by earnings per share, and analysts have already pencilled in a 6.3% decline in the distribution next year as earnings slide.
That being said, the City has a mixed record when it comes to predicting the future, so these forecasts could turn out to be too pessimistic. If that is the case, then the shares could turn out to be a great contrarian opportunity. Indeed, my Foolish colleague Roland Head believes the company remains a great long-term buy, a view he thinks is reinforced by Centrica’s 8% dividend yield and forecast P/E of 10.
