Centrica’s focus on narrowing its capex plan is important for 2025: RBC

Investing.com -- Centrica 's (LON:CNA)’ approach to capital expenditure will be a key issue for the company in 2025, as analysts at RBC Capital Markets stress the importance of a more defined investment strategy.

While the company has outlined a broad range of potential spending opportunities, RBC believes that sharpening its focus will help remove a current overhang on the stock and provide greater clarity to investors on Centrica’s long-term direction.

A critical decision looming over Centrica is its involvement in nuclear energy, particularly around Sizewell C.

RBC analysts expect that a decision on the nuclear project may align with the government’s budget announcement, which would also include details on the remuneration framework for successful bidders.

The recent government backing of Drax’s biomass projects suggests that support for baseload energy remains a priority.

However, RBC notes that Centrica will likely require a highly controlled execution risk to move forward with such a venture.

Beyond nuclear, Centrica has flagged various investment opportunities, but with limited visibility on many of them.

RBC points out that a clearer capex plan will be necessary to drive Centrica’s future growth, especially given its relatively flat earnings trajectory.

While the company has the financial capacity to make investments—with a net cash balance projected at around £2.6 billion for 2024—investors remain cautious about how these funds will be deployed.

Smart meters stand out as a concrete growth opportunity. Centrica plans to invest up to £900 million in smart meter installations by 2028, with an initial annual expenditure of £200 million to convert 40% of its 12 million meter points to smart meters.

RBC notes that valuations in the smart meter sector suggest strong value creation potential, with a recent report indicating that Scottish Power may sell its smart meter portfolio at around 11 times earnings.

The estimated 9% internal rate of return on smart meters presents a compelling case for continued investment.

Another pressing issue is the future of Centrica’s Rough gas storage facility, which provides half of the UK’s total gas storage. Centrica has committed to operating the facility for another year despite an expected £75 million loss.

However, RBC analysts believe that without government support, Centrica will not extend operations beyond 2025.

The UK’s reliance on limited gas reserves, particularly during periods of high demand and low renewable output, underscores the strategic importance of Rough.

RBC suggests that any government intervention would likely come at the last minute, with an extension agreement being the most probable outcome rather than a costly hydrogen conversion.

RBC also notes investor concerns about Centrica’s capital allocation strategy. The company is aware of market apprehension around inefficient spending and has indicated that it will take a measured approach.

If suitable investment opportunities do not materialize or are further delayed, RBC expects Centrica to consider returning more capital to shareholders, potentially through additional buybacks.

The current £300 million buyback program announced in December is set to run through September, but further shareholder returns could become a focus if capex remains constrained.

In the broader energy market, Centrica may see benefits from the UK’s planned merger with the EU carbon trading scheme.

RBC analysts point out that UK carbon prices have already risen by around 30% in recent weeks in anticipation of this move.

This could lift UK power prices by as much as £10 per megawatt-hour, which would be advantageous for Centrica’s infrastructure business, even though the company does not currently factor in extended lifespans for its nuclear assets beyond existing public timelines.

As Centrica approaches its full-year results, RBC does not anticipate major surprises given the company’s mid-December market update.

A supportive commodity environment should continue to benefit Centrica’s trading and infrastructure segments, and RBC’s 2024 earnings per share estimate of 19.6p remains slightly ahead of consensus at 18.6p.

The company’s net cash position is expected to remain strong, even if it pursues the upper end of its £800 million capex guidance.

RBC has made adjustments to its estimates, primarily reflecting accounting changes related to Centrica’s smart meter portfolio and the assumption that the Rough gas storage facility will not generate earnings beyond 2025.

While RBC continues to see value in Centrica, with the stock trading at around 4.5 times its estimated 2025 EBITDA, the firm emphasizes that greater clarity on capex will be crucial in shaping the company’s long-term investment case.

Without a clear investment strategy, Centrica risks stagnation in its earnings trajectory, making capital allocation decisions all the more critical for the company’s future.