Centrica shock profit warning will echo into next year

Centrica has handed wary shareholders a good reason to pull the plug after a shock profit warning.

Shocks

In its third quarter trading update, usually a dull one, the group reports that 823,000 customers left British Gas, the leading energy provider in the UK over four months to the end of October. The exact link to the profit downgrade is unclear, but the group now envisages full-year earnings per share coming in at 12.5p, around 17% lower than expected. A new operating cash flow forecast of more than £2bn is also light of market forecasts—by some £800m—after the £2.69bn generated in Centrica’s last financial year. The fall misses a long-standing pledge by the group to increase operating cash flow by 3%-5% per annum. Investors have also become increasingly sceptical about the group’s ability to come good on a two-year old plan to save £750m per year from 2020.

Easy target

Britain’s consumer and business energy market is one of the most competitive in the world and CEO Iain Conn has cited competition as a key reason as to why “service delivery with the Centrica Business energy supply businesses has been disappointing”. On top of that, the government has appeared determined this year to impose tariff caps, prompting most operators, including Centrica to state that such moves would be counterproductive. Pushing its own alternative, on Wednesday, the group said it would stop offering more expensive Standard Variable Tariffs, and urged the government to ban them outright. Centrica will not however, exit an increasingly difficult consumer market, unlike some rivals. The group’s size, visibility and to an extent, apparent willingness to accept social responsibilities that rivals do not have exacerbated exposure to competition from the smaller and nimbler rivals that have proliferated in recent years.

Dividend eyed

All in, Centrica stock had already fallen 30% over the year up till last night’s close. Investors have been weighing how much of a new threat the toughening environment is to the group’s dividend policy. Pay-outs are a sensitive subject after Iain Conn gutted the dividend soon after his arrival around three years ago.

Time to re-think E&P

The bad news about the group’s annual result is now in, but energy market pressures are unlikely to abate in 2018. That suggests another poor price return for the shares next year. We also expect the return of vocal investor criticism of Centrica’s retention of capital-hungry and sub-scale exploration and production assets. Signalling a rethink about that division would be one way 2018 could end more positively for the group.

Tech spec: no capitulation

The spectacular collapse of Centrica's stock on Thursday should not distract from the most obvious aspects of its technical chart: that it is now trading at its lowest since April 2003 after a down trend that will soon enter its fifth year. In situations like these, traders and investors will typically go on the lookout for signs of capitulation. If spotted, such indications could be potential buying signals. In Centrica's case, we do not see anything convincing along those lines, neither fundamentally nor technically. For one thing, whilst CNA has marked a low of 133.7p on Thursday, it found distinct support at a lower low in March 2003 at 115.02. The stock is also some way from the psychological price of 100p having listed in 1997 at 53p. So whether or not the fundamentals justify major holders throwing in the towel (they do not) on the evidence of the chart alone, the shares are likely to continue their slow drift lower, albeit they could find a temporary floor nearby.

To be sure, the optics of the stock's latest upset are undeniably negative and sentiment will stay poor for the medium term at least. That said, so long as the stock doesn't tarry for an extended period around either side of 133.7p (Thursday's low) a visit to 115.02p may not be seen too soon. The vacuum effect of the price gap between the prior day's low -- 160.04p and Thursday's high -- 145p will almost certainly pull the stock up. Note also that the Relative Strength Index sub-chart gives an over-sold reading of 19.04, its deepest decline since the RSI touched 18.04 on 15th October 2014. In other words, the upward impetus on Centrica stock at this point will become almost centrifugal in coming days. But it won't last. The downtrend is here to stay. Investors should be aware that the shares spent almost a year and a half consolidating support between 182p-194p before sentiment gave way in October. Beneath the range, it will act as resistance. The share cannot be expected to make significant upside progress before that barrier is cleared.

Figure 1 - Centrica Plc. share price chart (daily intervals)

Source: Thomson Reuters and City Index