Every portfolio needs a sold ‘backbone’ of defensive stocks with a predictable outlook, which can be relied upon to provide a steady income during times of market turbulence.
National Grid (LSE: NG), SSE (LSE: SSE) and Centrica (LSE: CNA) are three such backbone companies. In fact, all three companies have bond-like qualities, making them perfect investments even for the most risk-adverse investor.
That said, Centrica is currently trying to turn itself around, following a period of lacklustre business performance. However, the company has all of the tools at its disposal to instigate a successful turnaround while maintaining its dividend payout to investors.
Restructuring for growth
The primary nature of Centrica’s business is the generation and supply of gas and electricity to UK homes, a relatively stable and predictable business. The company has recently run into trouble with its upstream business, which is suffering from the weak oil price environment.
As a result, Centrica’s management is now looking to refocus growth efforts on customer-facing activities. £1.5bn of capital from the group’s upstream business that focuses on exploration, production and power generation, is being diverted towards downstream, customer-facing operations such as British Gas. Management is looking to cut day-to-day group costs by £750m between 2015 and 2020. 6,000 jobs will go at the company’s upstream arm as part of these changes.
I believe management’s decision to scale back Centrica’s upstream business is a great move for the company. Oil & gas production is a notoriously volatile and capital intensive business. Focusing on the more predictable customer-facing side of the business should put Centrica back on the path to sustainable long-term growth. Moreover, Centrica’s focus on the more predictable customer side of the business will help support the company’s dividend.
After slashing the dividend payout by 30% earlier in the year, Centrica’s payout of 12p per share now sits at a more sustainable level. The payout is now covered one-and-a-half times by earnings per share. At present, the company supports a dividend yield of 4.4%.
A better pick
Like Centrica, SSE is also selling of low return assets in favour of assets that generate a high return on investment and boost shareholder returns. And SSE is, broadly speaking, a stronger company than Centrica. A conservative growth strategy has helped the group perform well in a difficult trading environment.
For the past five years, SSE’s revenue has grown at compound annual growth rate of around 8% per annum, although earnings per share have slipped by 10% since 2011. Similarly, National Grid’s earnings per share have chugged steadily higher by 3.3% per annum since 2011. Additionally, over the same period, shareholder equity has expanded by 33%, and book value per share has grown at a compound annual growth rate of 13.5% per annum since 2010.
In other words, National Grid and SSE have both created a significant amount of value for investors’ during the past five years. SSE and National Grid’s shares have produced a total return of 15.0% and 15.8% per annum respectively since 2010.
The bottom line
So overall, SSE, National Grid and Centrica are three defensive investments that would sit well in almost any portfolio.
