Big Six energy company profits to drop 22%, Jefferies warns

Seeing "significant headwinds" for the Big Six energy companies profits due to increased competition and lower power prices, broker Jefferies has downgraded Centrica and Drax to 'underperform' ratings.

SSE was however felt better able to weather the storm and left at a 'hold' rating with a target price of 1,550p due to its business mix, strong balance sheet and dividend track record.

British Gas owner Centrica was cut from a previous 'buy' rating, with its target price lowered to 190p from 235p; and while Drax was moved down from its former 'hold' rating the price target was lifted to 240p from 210p.

"Falling commodity prices, evolving regulation and heightened consumer awareness will continue to benefit independent suppliers in the UK domestic energy supply market," Jefferies said.

By 2019, analysts expect the Big Six energy suppliers supply profits to drop by 22% due to an 11% market share loss to smaller players and an 80 basis-point margin squeeze.

Centrica, being the dominant supplier through its British Gas business and exposure to commodity prices, "will be hit the hardest".

Jefferies foresees 15% downside to current gas prices, but with the former share price driver of UK gas prices being less important for Centrica due to the expected 50% fall in upstream output this is seen as becoming "less relevant", with the UK retail business becoming the predominant driver of the FTSE 100 group's share price.

But while the downstream business is investing in 'smart home' and other residential customer products, analysts are cautious about potential returns "given the global technology companies Centrica is set to compete with".

On Drax, despite its increased earnings visibility relating to the biomass CfD contract and capacity market revenues, Jefferies said it expects recent outperformance to unwind "due to the downside we see to forward UK power prices".