Are Centrica PLC, SSE PLC And Drax Group Plc ‘Screaming Buys’?

Should you buy these 3 utility stocks right now? Centrica PLC (LON: CNA), SSE PLC (LON: SSE) and Drax Group Plc (LON: DRX)

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2015 has been a hugely disappointing year for investors in Centrica (LSE: CNA), SSE (LSE: SSE) and Drax (LSE: DRX). That’s because all three stocks have fallen during the course of the year and, despite apparently being defensive utility stocks, they have been outperformed by a falling FTSE 100.

In fact, while the FTSE 100 has slumped by 3% since the turn of the year, SSE has fallen by 7%, Centrica is down 18%, and Drax has seen its share price collapse by a whopping 43%. Looking ahead, though, the performance of the three stocks could be very different.

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The right time

A key reason for this as far as  Centrica goes is a new strategy which is likely to improve the company’s financial performance, provide increased resilience in future years, and also boost investor sentiment. That’s because the company will now move away from its aim of becoming a major oil and gas producer, with numerous assets set to be sold off in the coming years as Centrica seeks to become a pure play domestic energy supplier.

Although it could reasonably be argued that now is the wrong time to sell oil and gas assets, since their prices are heavily depressed, it appears to be the right time for Centrica to change its strategy. With annual cost savings of £750m, the company’s bottom line should seriously benefit from a pivot towards domestic energy supply and, with the oil price seemingly likely to remain at or around $60 over the medium term, selling up and moving on could prove to be a sound move and boost the company’s share price. With Centrica trading on a price to earnings (P/E) ratio of 12.8, there is significant rerating potential.

Hugely enticing

Similarly, SSE is also cheap at the present time. It trades on a P/E ratio of 13.3 which, while higher than that of Centrica, offers greater stability than its index peer. That’s because SSE is more reliant on the domestic energy supply market and, with a majority Conservative win at the General Election, the future of the industry and how it is regulated should be relatively secure in the coming years.

Like Centrica, SSE has a considerable debt pile and as interest rates rise the cost of servicing its borrowings could eat into profitability and also into dividend payments. However, SSE remains a hugely enticing income play, with a current yield of 6% and a dividend coverage ratio of 1.3. This shows that its dividend growth outlook remains sound, with the payout likely to increase by at least as much as inflation over the medium term.

Too downbeat

While SSE and Centrica appear to be worth buying, the investment case for Drax is less clear. Despite falling heavily this year (as mentioned), its shares still trade on a P/E ratio of 21.2. And, with net profit forecast to decline by 62% next year, they have a forward P/E ratio of 55.7, which indicates that they may have further to fall.

Although the plan to convert half of its boilers from coal to wood is a sound move, as a result of the UK’s continued move to greener, cleaner sources of electricity generation, the near-term outlook for the company remains too downbeat for it to be a buy at the present time. That’s especially the case since a number of other utilities offer generous yields, good value and some earnings growth potential.

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Peter Stephens owns shares of Centrica and SSE. 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.

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