Interactive Investor

Is Centrica’s magic bull run over?

Shares in the energy company have more than doubled in the past year, raising questions about valuation, whether they can go much higher, and alternative stocks to buy. One City expert shares their view on the British Gas owner’s future.

27th September 2023 13:15

by Graeme Evans from interactive investor

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British Gas and a flame 600

Morgan Stanley still sees a 14% upside to an improved price target of 190p, but with shares up by a sector-leading 116% over the past year it advises investors to start taking profits.

The bank downgraded its stance on the British Gas owner from “overweight” to “equal weight” and recommended switching to SSE (LSE:SSE) or Europe’s Engie SA (EURONEXT:ENGI) and Fortum Oyj (XETRA:FOT). Centrica retreated 6.3p to 159.85p as today’s second-worst performing stock in the FTSE 100 index.

Morgan Stanley said: “While we continue to see a strong, and in many divisions improving, operating environment for Centrica (LSE:CNA), we see few catalysts near term to drive further re-rating.”

The bank pointed out that a preference for shareholder distributions over growth investment had propelled Centrica's share price in the past year, driven by a backdrop of much higher interest rates and concerns around value creation on long-term investments.

While the bank does not expect an immediate shift in this mindset, it sees scope for the trends to reverse if investors re-engage with the renewables sector or yields start to decline.

It said: “In such a scenario, we would expect a rotation out of Centrica and into more obvious growth stories, preferring SSE in the UK.”

Centrica announced a significant jump in shareholder returns with July’s interim results, including a 33% rise in half-year dividend to 1.33p for payment on 16 November. It also extended its share buyback programme by £450 million.

Morgan Stanley sees £3.7 billion of free cash flow in the years 2023-26, equivalent to 40% of Centrica’s market cap and sufficient to underpin further upside to the buyback programme.

However, it believes this is priced in by the market and so unlikely to drive the shares higher.

On dividends, the bank is broadly in line with the wider City consensus after forecasting a 4p a share total payment for 2023, rising to 5p and 5.5p for the following two years.

On 2 April 2020, Centrica cancelled its 2019 final dividend payment of 3.5p share so it could save £204 million amid pandemic uncertainty. The shares hit a record low of 34p at about that time, with dividends only returning with last November’s 1p a share interim award.

Since then, the elevated and more volatile commodity environment has benefited Centrica’s upstream businesses as well as its Energy, Marketing and Trading division. The outlook for its retail division has also improved following regulatory changes, contributing to a 74% rise for shares year-to-date.

Morgan Stanley now sees Centrica approaching fair value and considers it an appropriate time for investors to trim positions and start taking profits.

However, the bank also highlights reasons why the shares may surprise on the upside. It said this could be due to commodity market volatility or because further increases to yields prolong investor interest in shorter-term distributions over longer-term growth.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

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