Broker tips: Centrica, Dignity

Kepler Cheuvreux has upgraded Centrica to 'buy' after shares of the energy provider fell past the broker's valuation of the business.

In a note to investors, Ingo Becker, Kepler Cheuvreux's head of utilities, said Centrica's low share price had created an opportunity for investors to "jump in".

Kepler Cheuvreux cut Centrica to 'reduce' in early 2016 when the shares were at 211p. Since then the shares have fallen 22% to well below Becker's price target of 190p. At 11:52 GMT the shares were trading at 166p.

Centrica's shares have dropped due partly to regulatory pressures and the government's decision to impose a cap on prices paid by households on variable tariffs. Centrica owns British Gas, the UK's biggest energy provider for consumers.

Nevertheless, Becker stuck by his original valuation and advised clients to take advantage of the buying opportunity.

Becker wrote: "Political and regulatory scrutiny of the industry […] might be pulling some of the pressure forward, but the overall intensity of pressures already modelled by us back then are now well covered by the share price. We currently see a market opportunity and recommend that investors jump in here."

Berenberg took an axe to its target price for Dignity, telling clients it is waiting to see how the firm responds to the competitive threat to its pricing power from new entrants into the market.

In a nutshell, death may be a certainty but sustained pricing power is not.

Unfortunately, the German broker's investment case for the shares was predicated on the company's long-term growth potential which in part relied on its ability to continue being a price-setter, as opposed to a price-taker.

So for the time being, its analysts lowered their target price from 2,950p to 2,350p, albeit while keeping their recommendation at a hold.

Nonetheless, the company's track record in delivering or beating consensus expectations was "strong", Berenberg said, and its delivery since IPO "exceptional".

Indeed, the analysts were very confident of Dignity's ability to meet or beat consensus in both fiscal year 2017 and 2018.

However, competition was building as the firm's 'good fortunes' attracted competitors.

"Increasing competition means that the company’s ability to continue raising prices at 5-6% pa looks uncertain. With management now examining various new pricing and service options, we see a risk that it is forced to moderate its pricing to chase lower-margin business. As a result, we reduce our long-run margin assumptions."