Sunday share tips: Centrica, Duke Royalty
In his ‘Inside the City’ column for the Sunday Times, John Collingridge was looking at Centrica, bringing it all the way back to the hefty dividend promises of the ‘if you see Sid, tell him’ marketing that accompanied the privatisation of the then-British Gas in 1986.
In recent times, however, those payout promises were looking to be under pressure, with Centrica - as the company has been known since itself and the BG exploration business were split in 1997 - sitting on top of what Collingridge called a “shrinking supply business”.
It was facing turbulence on all fronts, from rivals keen on Centrica’s customers, to rising input prices, to a Westminster government promising the public a cap on energy prices.
Its share price has collapsed in the last five years, ending last week at 146.2p, valuing the company at £8.2bn
Centrica’s profits fell 17% last year, which added to the pressure, with Collingridge noting that a small, but loud, minority of analysts were warning that the company would struggle to maintain distributions to shareholders going forward.
Chief executive Iain Conn slashed the dividend by 30% shorty after he took the reins in 2015.
A further cut would be sacrilege, given the company’s mammoth retail shareholder roll, with 500,000 investors holding 1,000 or fewer shares.
But Conn has a cunning plan to protect the dividend, with thousands of jobs facing the axe and many more looking at efficiency improvements, along with placing a cap on big investments and acquisitions, and keeping a lid on debt to hold interest payments at bay.
Given cash flow remains at around £2.1bn per year, Conn has said he believes he’ll have enough cash to pay shareholders - including Sid - at the current rate up to 2020.
Collingridge also noted that Conn has been trying to break Centrica free from the shackles of its heady nationalised days, moving the firm away from centralised power plants and towards distributed generation, such as smaller, local gas turbines.
He was also pushing high-technology in-home services, such as smart meters and boiler maintenance packages, which Conn believes will embed the company within households, preparing it for the next wave of change in the energy industry.
But Collingridge said he wasn’t so sure, questioning whether Centrica can actually grow service and distributed-power revenues at the same rate it was losing core business.
“Centrica is still a lumbering behemoth,” he quipped in his piece, saying he wouldn’t put money on it winning the technology battle against the likes of Amazon and Alphabet, whose smart platforms - Alexa and Google Home respectively - could evolve into smart meters themselves.
The company could lose control of its own future, Collingridge warned, asserting that another slip-up could see activist investors dig out their break-up plans again.
And there was growing competition from cash-rich oil majors, such as Total and Shell - which now owns the former BG exploration business - who have been testing the waters of the power supply market.
Centrica’s shares are at the cheap end of the market, but deservedly so, Collingridge reckons, with the current price possibly tempting a predator, such as an oil major, or a technology giant such as the Japanese SoftBank.
“It’s a stretch to see the logic, but stranger things have happened.”
Over in the Mail on Sunday, Joanne Hart was diving deep into her favourite London market - the Alternative Investment Market - for a look at Duke Royalty in her 'Midas' column.
Hart described Duke as a company specialising in royalty-style finance to firms in fields such as industry, leisure and technology.
She said the shares - currently 39p apiece - should “increase substantially” as the company expanded and developed, with a generous quarterly dividend policy and an annual yield of over 5% to boot.
Royalty finance is not a new concept, having been a factor in the mining industry for decades.
Miners keen for cash would borrow from such royalty lenders, in return paying a portion of their annual revenues to the financier.
In latter years, it has spread through the biotechnology industry, more recently becoming a source of cash for companies in a broader sense, Hart noted.
Duke was founded in 2015 by Neil Johnson, who previously spent 19 years at Canaccord Genuity, helping the firm’s London office increase European revenues to more than £50m from an initial £5m.
Hart said Johnson had equal, if not higher, ambitions for Duke Royalty, which has completed deals with three companies since listing on AIM in March Last year.
The first was Temarca, a 20 year-old Dutch river cruiser company, with mini-conglomerate Lynx Equity and veteran industrial paint company Trimite Global rounding out the trio.
All of those business could have headed cap-in-hand to a traditional bank, Hart said, but they went for royalty finance as it offered “particular benefits”.
Royalty deals typically had particularly long terms, between 25 and 30 years generally, with repayments varying from year to year depending on the performance of the borrower.
Importantly, firms repay both interest and principal from the start, meaning they did not have to face large lump sums as the debt fell due.
Duke also does not take equity in any of the business it lends to, meaning the company’s managers retained full control.
While the interest levels were similar to banks, demand remains high due to the more manageable structure of royalty finance, Hart claimed.
She said Duke is about to sign a fourth deal with a British glass manufacturer, with Johnson expecting to complete around six deals each year.
After the glass deal has gone through, the company would have lent just about £30m, which was expected to rise to around £50m in 2019 and 2020, and £100m after that.
But despite the demand, Duke remained extremely selective about the deals it signs, with Johnson’s team apparently already taking a look at 150 prospective borrowers - an approach it vows to maintain as it grows.
That growth would also mean asking shareholders for more cash, but Hart said Johnson would ensure a solid pipeline of deals before sending out circulars.
New shares would be offered at a discount, however, with new royalty agreements signed on terms favourable to Duke’s profitability and dividend potential.
As an example, Hart pointed to Duke’s £20m raising in December - it was at 40p a share when the market price was 42p, but it led to the Trimite deal and an increase to the dividend.
Johnson was also assembling an impressive team, with chief investment officer Jim Webster having pioneered the first publicly listed drug royalty company in 1993, and working in the industry ever since, raising £4bn for firms globally.
Its shareholder register was described by Hart as “reassuring” as well, with blue-chip names such as Axa Framlington, Hargreave Hale and Janus Henderson featuring.
Johnson and his fellow directors retained 12% of the company, too, incentivising them to maintain a solid business.
Duke’s books closed for the year on 31 March, with results due in a “couple of months”.
Brokers were anticipating profits of around £0.5m with a dividend of 2p, with next year set to be a banger, as profits rocket to £3.6m and a dividend improving to 3.2p.
“Royalty finance is a new concept in the UK for companies outside mining and biotech but it can certainly help businesses to grow without borrowing from banks,” Hart said.
“Duke Royalty is a relatively new business too but the management team know what they are doing, demand is there and the shares should rise, while offering healthy dividends too. Buy.”