It isn't enough to succeed, Gore Vidal said, others must fail. Utility giants Centrica(LSE: CNA) and SSE(LSE: SSE) may not be succeeding in their own right, but they will be emboldened by the failure of smaller rivals.
Joy of six
Both companies belong to so-called Big Six energy suppliers - British Gas, EDF, Npower, E.ON, ScottishPower and SSE - who thought they had the domestic utility market sewn up. But then a rash of smaller competitors started emerging, encouraged by the government in a bid to boost competition, with names such as Ecotricity, Good Energy, First Utility, Ovo Energy, The Utility Warehouse and Green Energy UK. There are now 41 companies competing for British households' business.
Investors who questioned whether the market could support so many got their answer with the collapse of smaller energy supplier GB Energy over the weekend. The company, which is thought to have around 160,000 customers, said that it's no longer trading due to "swift and significant increases in energy prices" that made its position untenable. Ofgem has chosen Co-operative Energy to take over its customers.
Smaller companies with shallow pockets have their work cut out grabbing market share while staying solvent. The plunge in sterling after Brexit turned up the heat, as imported gas and electricity prices increased in sterling terms. Small suppliers are at a competitive disadvantage because they struggle to forward buy energy and this bars them from accessing the best wholesale prices.
Some also secured share by offering lossmaking deals and many have now started raising prices for the autumn.
Analysts have warned of a domino effect with other small suppliers going to the wall, and this could be some much-needed good news for Centrica and SSE. Big is beautiful again, and not before time. SSE lost 50,000 customer accounts in the three months to June, with most switching to smaller rivals. British Gas suffered an even more dramatic outflow, with 400,000 households fleeing in the first six months of 2016, again, mostly to the independents.
Go with the flow
Both companies saw their profits hit by falling wholesale prices, while being simultaneously attacked for failing to pass on cuts to hard-pressed consumers. As smaller rivals get the chills, we may hear less criticism from politicians. It may also force regulator Ofgem to get tough and scrutinise suppliers' business models more closely as part of its market monitoring, slowing the flow of new entrants.
British Gas and SSE have both frozen standard household energy prices until March and April 2017 respectively, in the teeth of rising wholesale energy prices, which will squeeze margins. Credit Suisse estimates that the big six need to hike standard variable electricity tariffs 10% to maintain margins. Life will still be difficult.
Centrica's share price is 30% lower than five years ago, although SSE has done slightly better with 12% growth. Yet both remain highly attractive income stocks, yielding 5.81% and 6.21% respectively, if thinly covered at 1.4 and 1.3 times respectively. Earnings growth is forecast to be minimal, around just 3% or 4% over the next year. Both remain tempting if slightly shaky income plays and failures elsewhere will boost their chances of ultimate success.
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Harvey Jones 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.