These two stocks should be classic utility plays ? defensive and offering a steady income. Has it worked out that way in practice?
You’ve got the power
A dividend cut is always a shock but it doesn’t have to be the end of the world. British Gas owner Centrica (LSE: CNA) slashed its dividend by 30% in February 2015 after reporting a 35% dip in profits, a move that wiped £1.2bn off its share price. In February this year it cut its dividend again, by 11.5%, after reporting a 12% drop in group profits. Following that double blow you might not think there was any income left, but you would…
These two stocks should be classic utility plays — defensive and offering a steady income. Has it worked out that way in practice?
You’ve got the power
A dividend cut is always a shock but it doesn’t have to be the end of the world. British Gas owner Centrica (LSE: CNA) slashed its dividend by 30% in February 2015 after reporting a 35% dip in profits, a move that wiped £1.2bn off its share price. In February this year it cut its dividend again, by 11.5%, after reporting a 12% drop in group profits. Following that double blow you might not think there was any income left, but you would be wrong. Currently, Centrica yields 5.5%.
The company needs to pay a handsome dividend because share price growth has been downright ugly. It is down almost 10% over the past 12 months, against growth of almost 10% across the FTSE 100 as a whole. It still trades more than 30% lower than five years ago. Last year it was the tough commodity sector that was to blame for Centrica’s dividend misery, although it rose to the challenge with a raft of cost and efficiency savings.
This should help to keep the cash flowing, pay down debt, and fund those all-important dividends. A cold winter or a further rise in energy prices would help to give it an extra lift, but although gas and oil prices have shown some signs of life, the recovery appears to have stalled for now. Losing customers for six years in a row hasn’t helped either, even if it still boasts around 30 million.
Earnings per share (EPS) are forecast to fall 11% this year (the third successive annual drop) but there may be some respite with a predicted 6% rise in 2017. Operating at 12.4 times earnings and with the forward dividend covered 1.3 times Centrica looks solid, but is nobody’s dreamboat.
United we stand
This hasn’t been the best year for utilities, with water company United Utilities (LSE: UU) down 7% over the past 12 months. However, this follows a healthy run, which means its share price is still more than 50% higher than five years ago. There was some excitement in this usually becalmed sector last week when SocGen reversed its view on the “undervalued” stock from sell to buy and predicted that there was scope for special dividends. It said recent share price weakness now implies a total shareholder return of 18%.
United Utilities already yields a thirst-quenching 4.1% with scope for growth as management aims to deliver RPI-linked progression. It will be interesting to see whether this will be possible if inflation starts picking up as predicted, but should offer investors some respite from rising prices.
One concern with United Utilities is that after years of steady earnings per share they actually dipped 5% in the year to 31 March, and are forecast to fall another 5% to March 2017, before stabilising. Another is its high valuation, currently at 20 times earnings. However, the intensifying search for yield suggests that investors will stand squarely behind United Utilities. While not exactly a dream stock, it does at least offer some respite from the income nightmare.
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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.