Today I am looking at why investors should be on guard for a dividend cut at Centrica (LSE: CNA).
A long-term dividend favourite
Centrica has long been a favourite for investors seeking access to bountiful income flows from their investment portfolio. The business has lifted the full-year payout at a chunky compound annual growth rate of 7.4% during the past five years alone, keeping dividend yields comfortably above the UK blue-chip average.
And City analysts expect this trend to continue during the medium term at least. An 3.3% hike, to 17.6p per share is anticipated for 2014, and which is predicted to rise an extra 2.5% next year to 18p.
These projections create monster yields of 6% and 6.1% respectively. Not only do these figures trump a forward average of 3.5% for the complete FTSE 100, but a corresponding reading of 4.5% for the complete gas, water and multiutilities sector is also surpassed.
… but changing landscape could herald payment pressure
Still, I reckon the City’s outlook for Centrica’s dividends this year and next may not be all that it seems. Of course the biggest problem facing the company and its energy industry peers is the prospect of crippling regulatory changes intended to limit household bills, an issue which could hobble revenue expansion in coming years.
In a bid to strike back in the PR war, Centrica is likely to keep sizeable tariff rises at British Gas on hold, a strategy exacerbated by intense market competition. The effect of such turnover constraints, combined with the need to chuck vast sums of cash at keeping the electricity network up and running, is expected to result in a colossal 21% earnings slide this year.
And although a 12% increase is forecast for next year, medium-term dividend coverage still remains extremely meagre — a readout of 1.2 times and 1.3 times prospective earnings falls well short of the security benchmark of 2 times or above.
Meanwhile, rising debt levels at the company could also hamper Centrica’s ability to keep dividends moving forwards in the long-term. Net debt clocked in at a sizeable £5.2bn as of the end of June, up from £5.05bn as of the end of December and £4.3bn at the mid point of 2013.
The extent of possible regulatory changes, from strict profit curbs through to the prospect of a complete break-up, continues to weigh heavily on Centrica’s earnings and consequently dividend outlook. Against this backdrop I believe that the business’ payout potential could come under extreme duress.
