It’s been a rough time lately for British Gas owner Centrica (LSE: CNA) as the company’s share price has more than halved over the past four years. But despite three consecutive years of declining earnings, the company still pays out a dividend that currently yields 6.4%.
And there’s good news on the sustainability of this payout. Even as the company continues to lose retail customers, down 2.6% year-on-year (y/y) in H1 alone, its plan to dramatically trim costs and reduce its debt load is starting to pay off.
A whopping 9% cut to headcount y/y in H1 led to EBITDA rising a decent 2% to £1,293m while net debt fell 22% to £2,941m. This is only barely within the group’s year-end target range, but falling leverage should keep dividend payouts secure even as the company seeks to turn itself around.
However, I’d still be leery about buying shares of Centrica at their current valuation of 12 times forward earnings, which is only slightly below their five-year average, especially as competition from smaller upstarts intensifies.
Is the turnaround on track?
Centrica’s problems are more than matched by Marks and Spencer (LSE: MKS), where a series of management teams have managed to compound sector-wide challenges with internal mistakes. Yet the company still pays out a hefty 5.7% yield that is safely covered by earnings.
New CEO Steve Rowe also has a very sensible plan to return the company to profitable growth: bring its clothing lines back to the basics it was once known for; stop discounting so heavily and frequently; and focus on the one part of the business, grocery, that hasn’t been underperforming. It’s still early days in this plan but initial signs are somewhat positive with full-price clothing and home sales up 7% y/y in Q1 and food sales up a full 4.5%.
Unfortunately, total clothing and home sales still fell as less discounting turned away bargain hunters. But if this turnaround plan sacrifices discounted sales for more profitable full-price sales, Marks and Sparks could be on to something. But with it too early to tell and a staggering £1.93bn of net debt at year-end, I’d wait for further positive evidence before buying its shares.
Saving the best for last
A more interesting high-yielding option in my eyes is Vodafone (LSE: VOD) and its 6.2% yield. The telco is finally emerging from a multi-year £20bn+ infrastructure investment programme across Europe. Now that the heaviest investments are done, the company is just beginning to reap the rewards of faster broadband and 4G services that are drawing in customers.
In the year to March, the company’s service revenue, its preferred metric, rose by 1.9% y/y in organic terms to €42bn, while free cash flow leapt from €1.2bn to €4bn. This level of free cash flow covered dividend payments of €3.7bn and should finally allow the company to begin to put a dent in its €31bn mountain of net debt. While Vodafone’s hefty dividend now looks safe, investors should be wary of the company’s lofty valuation of 27 times forward earnings.
