Stockwatch: are bears right to bet against this FTSE 100 firm?

Since mid-January, there has been a large extent of shares spiking upwards – initially on Christmas or 2024 trading updates, then more specific business news and annual results which are now being published. The magnitude has been roughly 10% to 30% upside; understandable with small-caps low in their charts and where tight liquidity forces an inflection point, but FTSE 100 companies?

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Yesterday, energy producer/supplier Centrica (LSE:CNA) - a FTSE 100 company worth over £7 billion - rallied 10% to 150p by 9am on the back of its 2024 results. This was despite nothing special by way of “beats” in the numbers or statement. It was reported that the shares rose after the company increased its dividend, albeit a 13% increase to 4.5p was in line with expectations, and extended a share buyback programme by £500 million to £2 billion.

Perhaps the market is nowadays too attuned to buybacks, which are double-edged in the sense they affirm cash flow and provide near-term technical support, but can also signal a lack of worthwhile investment projects. In fairness to Centrica, its year-end cash was quite stable at around £6 billion versus £3.5 billion debt, so it is positioned to return capital.

I was still quite taken aback by the extent of share price rise given a lack of specific triggers in the statement. So might be hedge fund Marshall Wace, which increased its short position to 0.81% of the issued share capital, borrowing and selling another 0.1% - hence a near £60 million down-bet. This hedge fund is perhaps the most experienced in London on shorting. It cleverly built a 2.11% short in John Wood Group (LSE:WG.) before this contractor’s shares slumped last Friday.

In a medium-term chart context, Centrica’s volatility has a wider dimension - down from 170p in September 2023 to 115p last November and currently in a rising trend:

Source: TradingView. Past performance is not a guide to future performance.

Yes, the shares did steadily give back gains after 9am to close up 6% at 144p, but there remains a curiosity that this is another share responding positively to anything considered “not bad news”. And this is versus two hedge funds – Point72 Asset Management also disclosed 0.51% short as of 10 February – that believe Centrica’s risk/reward profile implies downside. It begs the question, is this trait now indicating a wider sentiment shift in the market, which started with sensitive small-cap, now manifesting itself among FTSE 100 constituents?

Market valuation profile falls between two stools

As I discussed in my last piece, changes in stock market valuation can hinge on whether a company is perceived to be in “growth” mode, or whether the shares more likely appeal for income – in which case the market tends to price for a meaningful yield.

Centrica is affirmatively neither. Yes, relatively recent numbers have been affected by the first-half 2023 energy crisis after which the regulator Ofgem allowed suppliers to recoup unexpected costs. But using the numbers Centrica highlights on its adjusted basis - revenue is down 26%, adjusted operating profit 44% and adjusted basic earnings per share by 43%.

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Comparisons are made tricky due to varying senses of “normalisation”, but the market consensus has so far expected a broadly declining financial scenario in 2025 and 2026 in most of Centrica’s numbers apart from dividends. In such a situation you would normally expect the market to price for a useful yield over 5%, but at around 144p currently and assuming published guidance for a dividend rise from 4.5p to 5.5p, the prospective yield is 3.8% with “a commitment to reach 2x earnings cover by 2028”.

Some £4.0 billion of net tangible assets as at end-2024 imply asset-backing at around 80p a share, hence with a conservative balance sheet I believe Centrica merits a “hold” stance – similarly as I rated it last April below 130p.

Back then, several US banks were bullish: JP Morgan asserted “overweight” at 133p and Goldman Sachs raised its target to 195p, implying nearly 50% capital upside. I found it quite an act of faith to share their optimism, and a month later the price hit 148p before falling to 115p in November.

How then, can big short positions be justified?

I do not believe the two reported short positions are simply part of a general investment strategy – hedging possible market volatility. These sellers’ UK shorts reflect targeting weaker risk/reward.

Amid controversy over BP’s strategy – prioritising renewables in the wider governmental shift to “net zero”, now being reversed under a new CEO and an activist shareholder – a cynic might say Centrica has made itself hostage to climate-change activism. Strategic highlights include: “Updated climate transition plan launched January 2025, bringing forward the target to be a net zero business by five years to 2040.”

Relative to BP in recent years however, Centrica strikes me as making itself compliant with the “net zero” mantra rather than a vigorous attempt to embrace green energy. By comparison, Octopus Energy boasts it “primarily purchases electricity from renewable sources” but is more agile as a supplier. This reflects the British Gas legacy of being an “integrated” energy group – producing besides selling. The 2024 adjusted operating profit breakdown shows retail contributing (before exceptional charges) 27%, oil & gas production plus nuclear at 50%, and energy trading plus business solutions at 24%.       

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Management says it has “ramped up” investment in “the energy transition” and is “£2 billion into a £4 billion investment programme”. More modest, however ,seems the cash flow statement citing a 24% increase in spending on property, plant, equipment and intangible assets, to £416 million, and business purchases nearly trebling to £92 million. This constitutes 44% of net free cash flow.

I sympathise with their dilemma given market expectations have shifted from being all for green energy some years ago, but currently back to fossil fuels. Anyway, perhaps energy price fluctuations are more significant than the “renewables” debate?

Centrica - financial summary
Year ended 31 Dec

Source: historic Company REFS and company accounts.

Retail side lagging relative to new operators

Late last year, British Gas lost its position as leading UK energy supplier to Octopus Energy - which now serves around 24% of householders versus British Gas at 23%, with some 300,000 fewer accounts. I am among them having once been a British Gas customer then switched to EDF and some years ago Octopus.

Octopus is a success story having founded in 2015, although it does show how growth in the sector is largely about customer switching and upgrades such as smart meters, while Centrica came unstuck in a 2023 scandal over the force-fitting of prepayment meters for vulnerable customers.

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A significant catalyst has been Octopus’s bespoke software - Kraken - enabling the supplier to offer tariffs that take advantage of real-time electricity price fluctuations to lower bills. Frustratingly for Centrica, Kraken is being licensed to other UK suppliers such as E.ON, EDF and the £90 million Good Energy Group (LSE:GOOD) listed on AIM.

At least British Gas offers heat pumps like Octopus, inclusive of government grants, although public enthusiasm has become muted given extensive and expensive internal home-works that may be required – such as interior insulation and radiator replacement – for a heat pump to work effectively.

An uneasy question regarding Centrica’s retail side is exactly why anyone should now switch (back) to British Gas. And, unfortunately, as with lots of people who used to be complacent customers before, I am probably among the masses thinking British Gas would have to be offering exceptional tariffs (at expense to margin though) to make me sign up.

Centrica’s results cite higher levels of customer satisfaction after a migration to a new service platform, although residential energy customers still declined last year. Yes, British Gas has a 4.2 out of five score on Trustpilot, but last year it was the energy supplier most complained about to the industry ombudsman, even when adjusting for its size. 

Possibly over-cautious forecasts?

I do not see any great positives or negatives in these results, or Centrica’s trajectory. Perhaps the shares - up 3% this morning to over 147p - are reflecting management’s guidance for “stable” (read “flat”) performance across key business segments in 2025, versus recent consensus for declines, plus the buyback programme renewal.

The shares are also firm versus the FTSE 100 index, which is slightly lower. If you hold, I would not fret about the short positions, but equally Centrica does need to prove it can grow in the longer term. Hold.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.