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Challenges leave Centrica dividend 'hanging by a thread,' analysts say

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Challenges leave Centrica dividend 'hanging by a thread,' analysts say

Centrica PLC, the owner of Britain's largest gas and electricity supplier, is facing a slew of challenges that will depress the company's earnings beyond market expectations and put its dividend at risk in the next two years, analysts at investment bank Jefferies said as they lowered their recommendation for the firm from "buy" to "hold" and slashed its price target from 170 pence to 125 pence.

Operational issues for Centrica's oil and gas production business and nuclear assets, the suspension of payments under the U.K.'s power capacity market, high customer churn rates, a tariff price cap and volatile commodity prices could all combine to drive the company's earnings per share as much as 10% lower than consensus estimates for 2019 and 2020, the analysts said in a note to clients on Jan. 7.

Jefferies estimates Centrica's EPS to decline by 8% this year compared to last year's earnings, which Centrica is forecasting at 11.5 pence per share but Jefferies sees at 11.1 pence. This would cut the company's operating cash flow and leave a 12-pence dividend per share "hanging by a thread," the analysts said.

Centrica's share price closed on Jan. 7 at 131.25 pence, down 4.41% in heavy trading.

The warning follows a downgrade from buy to neutral by UBS last month, when the Swiss investment bank cut its target price for Centrica from 165 pence to 135 pence and said the company's operating cash flow target of £2.1 billion to £2.3 billion billion was "only just" sustainable.

"If anything else goes wrong, the dividend would have to be paid out of debt," the UBS analysts said in a note on Dec. 5, 2018.

In order to reinforce its balance sheet and sufficiently insulate itself against commodity price swings, Centrica would need to raise about £1 billion from a sale of its stakes in eight U.K. nuclear plants operated by Electricité de France SA, the Jefferies analysts said. The company plans to get rid of the stakes by the end of 2020, chief executive Iain Conn told Reuters last June.

"With borderline credit metrics and limited capacity to absorb another hit, we see a timely disposal of Centrica's 20% nuclear stake as critical to strengthening the company's balance sheet, especially given the uncertain macro backdrop and volatile commodity price environment," the Jefferies analysts wrote.

The company, which owns British Gas PLC and also has a supply business in the U.S., warned in a trading update last November that a government-ordered price cap for retail tariffs from 2019 as well as outages at nuclear plants and oil and gas fields would reduce its operating profit by £70 million in the first quarter of the year. It is currently challenging the price cap in court, arguing that the regulator unfairly assessed wholesale energy prices in setting the limit.

Centrica also reported its U.K. home energy customer count fell by 372,000 in the four months to the end of October amid continued high levels of market switching and several rate increases.

Jefferies expects further disappointment from Centrica's next market update in February, forecasting that mild weather and a corresponding decline in residential gas volumes in the U.K. will have reduced its earnings further.