SILVER BULLETS - Espirito Santo Investment Bank incorporating ...
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THIRD QUARTER 2010<br />
Centrica<br />
Oasis in the UK<br />
Massive turmoil in Continental European utilities sets the UK<br />
surprisingly apart. Prime within this group is Centrica. We have long<br />
argued that earnings, dividend and cash flow sustainability is key in<br />
these turbulent times. Not only does Centrica offer this, but it also<br />
has sustainable growth - a precious commodity. With multiples in line<br />
with the sector, it is a steal, tripling sector EPS CAGR of 4% 2009-<br />
2013. We think that avoidance of the stock, simply because it is a<br />
consensus long, is misplaced.<br />
Utility sector in turmoil<br />
Many Continental European utility stocks are reeling from political backlash.<br />
Germany shocked the sector with a proposed windfall tax (even the companies did<br />
not see that one coming). Belgium has decided that might also be a good idea.<br />
Finland may follow suit with a tax discussed in 2009. Spain undid a decade of<br />
liberalization by freezing tariffs. French Finance Minister likes the idea of freezing<br />
gas tariffs, another step backward.<br />
Oasis in the UK<br />
Conversely, there has been no such talk in the UK. Nor do we think there will be.<br />
The over-riding rationale is that the UK is running out of power (see pg 14 of our<br />
Centrica Upgrade, 14 th June 2010). And this new government is more pragmatic,<br />
understanding these issues. Any sniff of a windfall tax would scare away muchneeded<br />
investment.<br />
Wrong to avoid a consensus long<br />
This is one of the more often-used excuses for not investing in Centrica. If nothing<br />
else, share price performance attests to the fact that this is a weak argument. Sure,<br />
we, like many investors, generally start from the principle that performance is likely<br />
to lie elsewhere than consensus views. However, in some cases, such as Centrica,<br />
the fundamentals and valuation stack up.<br />
Forecasts recently upgraded; consensus has to catch up<br />
On June 14 th , we raised our forecasts; we are now 1% to 8% ahead of consensus<br />
EPS in 2010-2012 and 9% to 21% for DPS. We believe consensus forecasts will rise<br />
as Centrica’s strategy delivers. Our changes reflect a mark to market in<br />
commodities and our expectations of a tighter generation market evolving in the<br />
UK, which favours cleaner generation and gas over coal. We continue to believe<br />
that Centrica’s growth strategy is largely deliverable. Growth comes from<br />
• British Gas Residential (electricity and gas supply): more stable margins<br />
with lower margin volatility and lower customer churn.<br />
• Services growth. We assume a doubling in EBIT by 2013.<br />
• Upstream gas: increased production from Venture and new fields.<br />
• Power generation: combination of higher CCGT output (as gas continues<br />
to displace coal in the merit order) and new offshore wind capacity.<br />
On sector multiples yet triple the growth<br />
On 14 th June, we raised our fair value by 9% to 375p per share, implying 26%<br />
upside. This reflects the improved cash flows we are now forecasting on the back<br />
of our earnings upgrades. Centrica looks attractive on multiples, trading at a 2010<br />
PE of 11.9x, in line with the sector average, yet offering far superior EPS growth<br />
(13% vs. 4% CAGR 2009-2013). Dividend yield of 5% is also tempting, with DPS<br />
growth matching EPS growth. A healthy balance sheet makes this even more<br />
compelling.<br />
http://www.execution-noble.com<br />
BUY<br />
26.4% upside<br />
Fair Value £3.75<br />
RIC, Bloomberg Code CNA.L, CNA LN<br />
Share Price £2.97<br />
Market Capitalisation £15,194<br />
Free Float 100.0%<br />
EUR 2009A 2010E 2011E 2012E<br />
Revenues m 21,963 22,716 24,169 25,586<br />
EBITDA m 2,538 3,062 3,325 3,884<br />
EPS 0.22 0.25 0.27 0.32<br />
DPS 0.13 0.15 0.16 0.19<br />
FCF ps 0.32 0.20 0.17 0.26<br />
EV 20,233 20,233 20,233 20,233<br />
Net Debt 3,386 3,609 4,411 4,813<br />
Net Debt/Ebitda 1.3 1.2 1.3 1.2<br />
At Current Price: 2009A 2010E 2011E 2012E<br />
PE 13.7 12.0 11.1 9.3<br />
EV/Ebitda 8.0 6.6 6.1 5.2<br />
Dividend Yield (%) 4.3% 5.0% 5.4% 6.4%<br />
FCF Yield (%) 10.9% 6.9% 5.7% 8.8%<br />
At Target Price: 2009A 2010E 2011E 2012E<br />
PE 17.3 15.1 14.0 11.8<br />
EV/Ebitda 10.6 8.8 8.1 6.9<br />
Dividend Yield (%) 3.4% 4.0% 4.3% 5.1%<br />
Analysts<br />
Lawson Steele<br />
+44 20 3364 6771<br />
lawson.steele@execution-noble.com<br />
Andrew Fisher<br />
+44 20 3364 6773<br />
andrew.fisher@execution-noble.com<br />
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