Centrica (LSE: CNA) (NASDAQOTH: CPYYY.US) currently offers a prospective yield of 5.4%, but how safe is this payout?
Utility stocks including Centrica fell sharply on Monday, ahead of the publication of a report later this week, in which regulator Ofgem is expected to call for a full-scale investigation of UK energy utilities by the Competition and Markets Authority.
Among the potential outcomes of such an investigation are energy price caps and even the forced break-up of some utilities — something that would have serious implications for Centrica and SSE shareholders. I’ve been taking a closer look at some of Centrica’s key financial ratios to look for any early signs of trouble.
1. Operating profit/interest
What we’re looking for here is a ratio of at least 1.5, preferably over 2, to show that Centrica’s earnings cover its interest payments with room to spare:
Operating profit excluding exceptional items / net finance cost
£2,518m / £243m = 10.4 times cover
Centrica’s interest costs remain well covered by its operating profits, which suggests that the group’s debt costs don’t pose an immediate threat to its dividend.
2. Debt/equity ratio
Commonly referred to as gearing, this is simply the ratio of debt to shareholder equity, or book value (total assets – total liabilities). I tend to use net debt, as companies often maintain large cash balances that can be used to reduce debt if necessary.
At the end of 2013, Centrica reported net debt of £5,312m and equity of £5,192m, giving net gearing of 102%. Although this is relatively modest for a UK utility, around half of Centrica’s profits come from its oil and gas business, where a much lower level of gearing is typical, and profits can be more volatile.
As a potential shareholder, I wouldn’t like to see Centrica’s gearing rise much higher than it already is.
3. Operating profit/sales
This ratio is usually known as operating margin, and is useful measure of a company’s profitability.
Operating profit excluding exceptional items / group revenue
£2,518m / £26,571m = 9.5%
Centrica’s generous adjusted operating margin of 9.5% certainly won’t help the firm convince voters and politicians that its profit margins are not too high!
Centrica’s residential arm, British Gas, has a market share of around 30% in the UK. Any reduction in the profit margins it is permitted to earn would hit Centrica’s profits hard, and could put the firm’s dividend at risk.
The only safe utility dividend?
In my view, Centrica remains a sound long-term income buy, but I believe that possible regulatory action to improve competition in the UK energy market is likely to lead to a dividend cut for shareholders. As a result, I’ve been scouring the market for a safer home for my utility investment cash.
