Forget the Centrica share price, I’d buy this 4.8% yield instead

Centrica plc (LON: CNA) might look attractive but its long-term outlook is bleak, says Rupert Hargreaves.

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At the time of writing, shares in British Gas owner Centrica (LSE: CNA) yield a highly attractive 8.9%, according to City forecasts. This is almost double the FTSE 100 average of 4.8%.

But while this market-beating dividend yield might look attractive, I’m not a buyer of the Centrica share price. I think there are plenty of other dividend stocks out there with brighter outlooks. Today, I’m looking at one of these opportunities.

Losing money

Shares in Centrica might look attractive today, but the company’s record of creating value for investors is, quite simply, terrible. 

Over the past 10 years, shares in the company have returned just 0.25% per annum, including dividends, which implies you would have been better off keeping your money in a savings account rather than owning the shares. Over the past five years, Centrica’s performance is even worse. Including dividends, the stock has returned -10.5% per annum since January 2014 (although it has outperformed in 2018). 

By comparison, the FTSE 100 has returned 3.9% per annum for investors (over the past decade, the UK’s leading blue-chip index has returned 8.3% per annum).

Performance issue 

Centrica has been dogged by a series of performance issues over the past 10 years, and it doesn’t look as if it’s going to get any easier for the company anytime soon. The government’s price cap is almost certain to hit profitability, and the business is losing hundreds of thousands of customers to competitors. 

Analysts expect Centrica’s earnings per share (EPS) to drop a staggering 51% for 2018 to 12.3p. Only a small recovery is expected in 2019. Based on these figures, even though the shares have declined nearly 50% over the past two years, they still don’t look particularly cheap. Indeed, at the time of writing, shares in Centrica are trading at a forward P/E of 11.

A better buy? 

Considering the above, I’m in no rush to buy Centrica. The company’s yield might look attractive, but I think the shares could fall further if earnings continue to deteriorate.

With this being the case, I reckon Drax (LSE: DRX) could be a better income buy. Shares in this power station owner yield 4.8%, according to City forecasts for 2019, which looks disappointing compared to Centrica’s 8.9% distribution. 

However, analysts have pencilled in EPS growth of 183% for 2019, as the firm’s recent acquisition of a portfolio of power generation assets from the Scottish Power Generation Group starts to yield results.

Predictable business

I reckon Drax is also a better investment than Centrica because the company doesn’t have to compete for customers. Power generation is a relatively dull and commoditised business, and demand should only grow going forward.

What’s more, Drax doesn’t have to worry about enticing retail customers and dealing with complaints. The enterprise also has more scope to expand, because setting up power plants is highly regulated and costly, so Drax has few natural competitors. By comparison, setting up an retail supply energy business to compete with Centrica is relatively easy.

That’s why I think Drax is the better income buy, despite its lower yield. The company has more scope to grow, and I reckon its dividend is more sustainable as a result.

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 considered so you should consider taking independent financial advice.

Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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