Centrica (LSE: CNA) and AO World (LSE: AO) are two stocks Im steering clear of for 2016. Let me explain why.
Centrica
Companies are always evolving, but utility Centrica has made a number of major lurches in direction since it emerged as one of three separate companies from the break-up of British Gas plc in 1997.
The company immediately embarked on diversifying beyond its core British Gas retail and other energy operations by acquiring breakdown company the AA, telecoms operator OneTel and the Dyna-Rod franchise group, as well as developing the Goldfish credit card.
Five years later, Centrica decided it no longer wanted to be a diversified conglomerate and sold off most of the businesses it had bought.
From the mid-Noughties, Centrica focused on developing itself as a vertically-integrated energy company, led by new chief executive Sam Laidlaw, who brought significant experience of upstream operations. Mr Laidlaw departed at the end of 2014, having been moaning for some time about unprecedented political and regulatory scrutiny, including of the relationship between energy companies upstream and downstream businesses.
New chief executive Iain Conn, who came from a contrasting downstream background to his predecessor, initiated a strategic review. In July, Mr Conn announced: The conclusion of our strategic review provides a clear direction for the business .. we will focus our growth ambitions on our customer-facing activities. The upstream business will be reduced, including by divestments.
City analysts expect Centrica to post an 8% earnings decline for 2015, following a 28% fall in 2014. With the shares not much above multi-year lows hit in December, the price to earnings ratio is an attractive-looking 12 and the dividend yield is a juicy 5.6%.
However, the low oil price will continue to impact on the company. Adverse weather conditions have also hurt in recent times; something that could continue for the next couple of years, if Met Office forecasts are on the button. Political and regulatory risk hasnt gone away. And, finally, the big question: Will Centricas latest clear direction for the business deliver?
Given the headwinds, and the early stage of executing on Mr Conns vision, Im avoiding Centrica for now.
AO World
AO World, the online retailer of household appliances, is a company Ive always been bearish on since its stock market flotation at 285p a share in March 2014. I thought the valuation was way too high a year ago at 250p, and still too high at 178p last summer. With the shares now at 150p, is it time to turn bullish?
The table below shows some numbers for today and on a couple of the previous occasions Ive written about the company. Revenue and earnings are for the established UK business so exclude the current small sales and negative earnings from the recent expansion into Europe.
| Today | May 2015 | December 2014 | |
| Share price | 150p | 178p | 250p |
| Market cap | 631.6m | 751.6m | 1,052.6m |
| Net cash | 29.6m | 43.9m | 43.9m |
| EV (market cap minus net cash) | 602.0m | 707.7m | 1,008.7m |
| Revenue (ttm) | 502.4m | 472.5m* | 428.5m |
| Adjusted EBITDA (ttm) | 14.2m | 16.5m* | 15.1m |
| EBITDA margin | 2.8% | 3.5% | 3.5% |
| EV/EBITDA | 42.4x | 42.9x | 66.8x |
* Company guidance at the time
As you can see, despite the fall in the share price since May, the valuation of EV (enterprise value)/EBITDA (earnings before interest, tax, depreciation and amortisation) is virtually unchanged.
I maintain that the valuation is way too high for a low-margin business in a highly competitive sector of the retail market, so I will continue to avoid the stock.
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G A Chester has no position in any shares mentioned. The Motley Fool UK has recommended Centrica. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
