Here’s why the Centrica dividend doesn’t attract me

Christopher Ruane weighs some pros and cons he sees in the Centrica dividend and explains why he has no plans to invest in the British Gas owner.

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When it rains, it pours. That seems to be the case with cash flows at energy company Centrica (LSE: CNA). Last year, it generated £2.2bn in free cash flow from continuing operations. That is equal to over a quarter of its current market capitalisation. But despite that massive cash generation, the current Centrica dividend yield is under 3%.

Here is why the yield is low.

Yield involves dividend and share price

A dividend yield is the dividend as a percentage of the current share price. So if I bought its shares today, the current Centrica dividend yield would be 2.9%. Partly though, that reflects the increasing Centrica share price.

It is up 43% in five years. It is up 331% since March 2020. So if I had bought the shares then, I would now be earning a yield of over 12%. Tasty!

Limited enthusiasm for paying dividends

But while the share price is one part of the equation, so too is the dividend per share. Last year saw the Centrica dividend rise by a third, which sounds like a big jump. But it is still beneath its 2019 level — and far below what it used to be. In fact, it is less than a third of what it was a decade ago.

Centrica has been rolling in spare cash. Last year it spent £623m buying back its own shares, for example. I have my doubts about whether that was a good use of funds, given how much more expensive those shares would have been compared to a few years previously. But it shows that Centrica has been generating plenty of spare cash.

So why has it used that to fund buybacks rather than increase the dividend more? One explanation is that management seems to lack enthusiasm for juicy Centrica dividends. Dividends were suspended altogether in 2020 and 2021 and remain at a lower rate than before.

An alternative explanation is that uneven profits mean that future free cash flows may be lower than current ones. Using some spare cash to fund buybacks gives the company more flexibility to maintain the dividend even if cash flows fall, as it is only using part of its current buoyant cash flows to fund the shareholder payout.

Why I’m not tempted

With strong brands like British Gas and a market leading position in gas distribution, there is potential for Centrica to continue generating significant free cash flows. When prices are weak, cash flows may fall, but when prices are high as they have been lately, this can be a very lucrative market.

In a statement today (5 June), the company said this year’s performance should be in line with market expectations.

Asset sales several years ago transformed the company’s balance sheet, so free cash flows can now more comfortably fund dividends rather than paying interest.

In the long term though, gas use is in structural decline and I expect it to stay that way. Centrica has spent years struggling to deliver the level of service customers expect and has scored repeated own goals when it comes to dealing with people, whether customers or its own staff.

The Centrica dividend is growing — but is a shadow of its former self. I have no plans to buy.

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.

C Ruane has no position in any of the shares 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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