Is Centrica PLC A Better Buy Than Pennon Group plc And Drax Group Plc?

Which of these 3 utility companies will produce the best returns? Centrica PLC (LON: CNA), Pennon Group plc (LON: PNN) or Drax Group Plc (LON: DRX)

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

sdf

The performance of a number of utility stocks has been rather disappointing during the course of 2015. A key reason for this is an expectation that interest rates will begin to head northwards, which makes their yields less appealing and also may mean that the cost of servicing their often large amount of debt becomes more expensive.

For example, Centrica (LSE: CNA), Pennon (LSE: PNN) and Drax (LSE: DRX) have posted share price falls of 16%, 20% and 40% respectively since the turn of the year.

However, the reality is that, while interest rate rises are almost a certainty in the coming years, the pace at which they will rise is unlikely to be rapid. That’s because the global economy remains a rather uncertain place and, while the UK economy is performing well, it could easily catch a cold if China sneezes. As such, policymakers are unlikely to risk the current purple patch of economic growth just to push interest rates higher. And, with inflation being near-zero, the risk of deflation remains, thereby making brisk rate rises very unlikely.

Due to their share price falls, the likes of Centrica, Pennon and Drax now offer even more appealing yields. For example, Centrica currently yields 5.2% even after cutting its dividends by 30% earlier in the year, while Pennon and Drax yield 4.6% and 2.3% respectively. Clearly, Drax’s yield is less enticing than those of Pennon and Centrica and, with the biomass/coal power station set to post declines in earnings during the next two years, it is expected to slash dividends by 44% next year, which puts it on a forward yield of just 1.3%.

Also making Drax unfavourable versus Centrica and Pennon is its lack of diversity. It is a single site operator and, while its transition to biomass is a sound strategy given the emphasis on cleaner electricity production, the profitability of doing so remains questionable. For example, Drax’s forecast of earnings per share of 5p next year is less than 8% of its level in 2010, which indicates that investor sentiment could continue to slide.

Meanwhile, Centrica’s business model is also somewhat unfavourable. It has been hurt by a lower oil price and, while under previous management it had ambitions to become a major oil and gas producer/exploration play, new management do not share these ambitions. As such, Centrica will focus on domestic energy supply and sell a number of high value assets over the coming years. This has the potential to improve investor sentiment, although the company’s share price performance may remain somewhat volatile in the meantime.

Because of this, Pennon seems to be the best buy. As a water services company, it is a very stable business and offers reliability and resilience for its investors. Furthermore, with the water services sector being the subject of persistent M&A rumours, a bid for Pennon would not be a major surprise which, alongside a top notch yield, makes it the pick of the three utility companies.

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.

Peter Stephens owns shares of Centrica and Pennon Group. 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.

More on Investing Articles

A senior man and his wife holding hands walking up a hill on a footpath looking away from the camera at the view. The fishing village of Polperro is behind them.
Investing Articles

3 shares that could help a SIPP double in value

Christopher Ruane discusses a trio of FTSE 100 shares that he thinks investors should consider for their long-term potential to…

Read more »

Three signposts pointing in different directions, with 'Buy' 'Sell' and 'Hold' on
Investing Articles

I’ve doubled my money on this growth stock but I’m not selling it any time soon

Uber has been a great investment for Edward Sheldon, rising more than 100% in just two years. He believes the…

Read more »

British union jack flag and Parliament house at city of Westminster in the background
Investing Articles

The FTSE 100 is on fire! Yet these 2 stocks still look cheap to me

Despite the FTSE 100 hitting record highs, there’s no shortage of undervalued opportunities across the index, says Ben McPoland.

Read more »

Female student sitting at the steps and using laptop
Investing Articles

Greggs shares: an outstanding bargain after crashing nearly 40%?

Shares of one-time market darling Greggs have been in foul form recently. But is this a once-in-a-blue-moon opportunity for our…

Read more »

Close-up of children holding a planet at the beach
Investing Articles

This FTSE 100 stock’s suddenly become the highest-yielder on the index!

The league table of FTSE 100 (INDEXFTSE:UKX) dividend stocks has a new number one. But our writer explains why there…

Read more »

Rear View Of Woman Holding Man Hand during travel in cappadocia
Investing Articles

Is this under-the-radar UK stock as cheap as its rooms?

Our writer’s been keeping an eye on a little-known UK stock that operates in a niche, but profitable, sector of…

Read more »

Young Caucasian woman holding up four fingers
Investing Articles

It’s a ‘Fabulous Friday’ for holders of these FTSE 100 shares!

Four members of the FTSE 100 (INDEXFTSE:UKX) are making their latest dividend payments today (11 July). Our writer takes a…

Read more »

Man riding the bus alone
Investing Articles

Check out this spectacular FTSE 250 stock

UK investors willing to look beyond the FTSE 100 can find some outstanding companies. Online advertising business Baltic Classifieds might…

Read more »