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Should investors give Centrica the cold shoulder?

Warmer-than-normal weather so far in 2017 on both sides of the Atlantic might be good news for the British and American public, but the sun has not been shining on utility struggler Centrica. With electricity consumption down and in an uncertain regulatory environment, the owner of British Gas is in trouble.

Year-to-date, Centrica's share price is down 15% after falling as much as 2.5% Monday to a 15-month low, although bargain hunters have since chased them higher.

In a first-quarter trading update ahead of its AGM, the £11 billion company reaffirmed that it is on track to achieve targets for the full-year set out in its preliminary results, including operating cash flow of over £2 billion and efficiency savings of £250 million.

Net debt is expected to be between £2.5 billion and £3 billion, and positive momentum in the US continues.

However, British Gas is haemorrhaging customers, with over quarter of a million in the first three months of the year joining the 400,000 that deserted the energy supplier last year. It's the first time since the 1970s that British Gas's UK residential customer count has fallen below 14 million.

Elsewhere, UK wholesale oil, gas and baseload prices have fallen since Centrica's February prelims and it is currently awaiting the political party manifestos ahead of June's general election.

Both the Conservatives and Labour are tipped to announce price caps on energy tariffs as an election vote-winner. The Tories reckon political intervention will knock an average £100 per year off consumers' energy bills.

But Centrica hit back, claiming "evidence from other countries would suggest this will lead to reduced competition and choice, and potentially higher average prices". It went on to add that it was "competitively well-positioned" for changes. Let's hope so.

Has Centrica bottomed out?

Broker UBS has already downgraded its view on Centrica due to the potential of an energy tariff cap, which it said back in April is now more likely. It reduced its recommendation from 'buy' to 'neutral', slashing its 12-month target price by 16%.

It reckons a cap on the standard tariff could reduce retail margins by a third from 2018 – a conservative estimate on which to base its new target price. "[We] reduce target price to 215p, reflecting both a lower earnings per share (EPS) and a higher required dividend yield to recognise the higher risk on the shares," analyst Sam Arie explained.

"In the downside case, if margins were reduced by two-thirds, the shares could fall to 185p." It's unlikely we will have full visibility until some time after the election, though. This, Arie says, means the shares are unlikely to regain ground in the coming months.

The chart above shows historic support at around the current 200p level (pink line), and this appears to be holding up again. Centrica shares aren't obviously expensive either.

On UBS estimates for 2017 earnings per share (EPS) of 15.9p and 15.6p next year, they trade on a forward price/earnings (PE) ratio of 12.5 versus 14 times in recent history. UBS forecasts are is conservative, too. Using more generous consensus estimates brings that PE multiple down even further. And a prospective dividend yield of over 5% is also attractive.

That said, political uncertainty creates problems for investors ahead of next month's general election, and this is one for the brave just now.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. 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.

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