The Centrica (LSE: CNA) share price has slumped nearly 40% over the past year. After this decline, the stock supports a dividend yield of just under 9%, which is extremely attractive for income seekers in the current interest rate environment.
However, I believe that it can only be a matter of time before the company has to reduce this distribution. With that being the case, I would instead invest my money in the FTSE 100.
Today I’m going to explain why I hold this viewpoint and why I think you should consider adding the FTSE 100 to your portfolio as well.
A dividend cut
There has been growing speculation over the past few months that Centrica will cut its dividend this year. The company is facing a wave of problems, including rising costs at its nuclear power plants and oil and gas divisions, as well as falling customer numbers at British Gas.
To offset these issues, Centrica has been investing heavily in its digital business and US arm. However, none of these businesses are anywhere near maturity. The digital business, for example, is to lose tens of millions of pounds over the next few years as management ploughs money into marketing and customer acquisition.
To try and give the company some breathing room, management is reportedly seeking buyers for its oil and gas business as well as Centrica’s nuclear business. It may be some time before there’s any movement on this front. I would not count on asset sales coming to rescue the dividend any time soon.
Personally, I would like to see Centrica cut its dividend and use the cash to reinvest in the business. Last year, the distribution cost a total of £550m, which is money that could be used for improving things like customer service. British Gas currently has the worst rating of any utility provider for customer service, and it is going to continue to haemorrhage customers until this is sorted.
I don’t think management is likely to take this drastic action, but I do think the chances of reduction in the distribution are high.
International diversification
Some of the problems affecting Centrica are self-inflicted, but others are out of the company’s control, such as the government price cap and competition in the utility industry. If the international operations were more mature, it might be able to weather the storm better.
This is one of the reasons why I like the FTSE 100 is an income investment. Nearly two-thirds of FTSE 100 profits come from outside the UK, so this is a genuinely diversified index.
In my opinion, this makes the index’s dividend yield much more secure, because it is drawn from profits generated around the world, and not overly concentrated in one market or another. On top of this, the FTSE 100 gives you exposure to a range of different industries and sectors.
All of the above tells me that the FTSE 100’s dividend yield is much more secure than that of any one single company. Indeed, for the yield on the index to drop to zero, every constituent would have to cut their dividends.
So, even though the FTSE 100’s dividend yield of 4.7% is significantly less than Centrica’s 8% yield, the international diversification of the income stream, makes it, in my mind, the better buy.
