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For value investors scouring the market, utility stocks can often serve up attractive opportunities. One name that may be piquing interest lately is Centrica (LSE:CNA), the owner of British Gas. With the shares trading at just 1.7 times trailing earnings, the stock looks undeniably cheap on a traditional valuation basis. But does this signal a bargain or is there an underlying risk being priced into the Centrica share price?
Positive signs
Centrica’s price-to-earnings (P/E) ratio of 1.7 times is well below the market average of 16.6 times for UK companies. Even compared to other utility sector peers, the shares appear to trade at a discount. The share price has had a decent time over recent months, with a 13% gain in the last year. This sits well above the sector average, which declined by 3% over the same period.
It’s worth noting the company turned profitable again in 2023 after a few challenging years. This improved profitability could bode well for the firm’s ability to sustain its newly reinstated dividend, which currently yields a healthy 3.1%.
Analysts are decidedly bullish as well, with the consensus price target implying a roughly 32% potential to rise from current levels. The robust forecast suggests analysts expect the company’s value attributes to be recognised more fully by the market over time.
Risks
However, it’s not all sunshine here. A closer look at the company’s forecasts suggest declining earnings. Profits are projected to shrink by a whopping 41%+ annually for the next three years. This erosion in earnings power could put major pressure on the dividend and share price down the road, especially with the wider sector still expected to grow at about 8% per year.
A discounted cash flow calculation (DCF) also suggests that the business is already 21% overvalued. For me, this pours cold water on any potential excitement about the company trading at a steep discount.
The utility company has historically demonstrated an inconsistent dividend track record as well, which may give income investors some pause.
Another factor to consider is sensitivity to the broader economic environment in the UK. As an integrated energy provider to residential and commercial customers, the firm’s volumes and pricing power could be impacted by any prolonged recessionary conditions or demand weakness. Such exposure is front of centre for investors as the countdown to the General Election continues.
Am I buying?
All things considered, the company presents an interesting value proposition for investors. Those focusing on specific metrics may have perfectly valid arguments about whether the Centrica share price is overvalued or at a discount. I’m not a fan of uncertainty when it comes to my money, so for that reason, I’ll be steering clear for now.
