One dividend dud I’d sell to buy Centrica plc

7% yielder Centrica plc (LON:CNA) may now be a contrarian buy, says Roland Head.

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Shares of the world’s largest interbroker dealer TP ICAP (LSE: TCAP) fell by more than 5% on Friday, after the company released a rather downbeat third-quarter update.

The group said that although revenue during the three months to 30 September rose by 3% to £420m, “the outlook for the fourth quarter revenue remains challenging”. The company generally sees higher levels of activity among its clients when markets are more volatile than they are at present.

That makes last year’s fourth quarter — which included the election of US President Trump — a tough comparison for this year.

Another unexpected piece of news is that CFO Andrew Baddeley, is stepping down from the board “with immediate effect”. No explanation is given for this sudden decision, but Mr Baddeley has agreed to stay on to help with the transition.

For me, the underlying message behind Friday’s trading update is that the outlook is uncertain. Although today’s revenue figures were in line with City forecasts, the tone of the statement didn’t seem very positive.

Buy or sell?

In fairness, the group has delivered a solid performance so far this year. TP ICAP shares have risen by 22% since 30 December, when the merger between Tullett Prebon and ICAP’s brokerage unit was completed. The stock is now trading at post-2008 highs, but I’m not sure the current outlook justifies such as strong valuation.

At 505p, the stock trades on a 2017 forecast P/E of 15 with a prospective yield of 3.3%. Although performance is expected to improve next year, this valuation doesn’t seem compelling to me. I’d be tempted to take some profits.

I’m warming to this 7% yield

Utility group Centrica (LSE: CNA) has fallen firmly out of favour with the market this year. The group’s stock has lost 28% of its value so far in 2017. Only three of the 20 brokers who cover the stock have a ‘buy’ recommendation on it.

But all is not necessarily lost. Work is ongoing to position the business for the future. One example of this is today’s news that the firm has acquired REstore NV, a company which helps a number of large European industrial businesses manage their power requirements cost-effectively.

UK investors should also remember that in addition to British Gas, Centrica has a US utility business and an oil and gas production unit, which could benefit from the recent rise in oil prices.

Buy or sell?

Centrica’s adjusted earnings per share are forecast to fall by 10% to 15.2p this year, but this is expected to be a low point. Analysts have pencilled in a 5% increase in earnings per share for 2018, putting the stock on a modest forecast P/E of 10.4.

The group’s dividend is also expected to remain safe. Cash generation has been good over the last couple of years and net debt has fallen from a peak of £6.5bn to about £3.8bn. A dividend of 12.2p per share is forecast for this year, giving a chunky prospective yield of 7.3%.

Although this situation does carry some risk, I may top up my personal holding over the next few weeks.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head owns shares of Centrica. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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