The ability to calculate the reliability of dividends is absolutely crucial for investors, not only for evaluating the income generated from your portfolio, but also to avoid a share-price collapse from stocks where payouts are slashed.
There are a variety of ways to judge future dividends, and today I am looking at Centrica (LSE: CNA) to see whether the firm looks a safe bet to produce dependable payouts.
Forward dividend cover
Forward dividend cover is one of the most simple ways to evaluate future payouts, as the ratio reveals how many times the projected dividend per share is covered by earnings per share. It can be calculated using the following formula:
Forward earnings per share ÷ forward dividend per share
Centrica is expected to produce a dividend per share of 17.3p in 2013, according to City analysts, with earnings per share anticipated to tally up at 27.9p. This provides dividend cover of 1.6 times projected earnings, below the widely held security benchmark of 2 times. However, Centrica’s operations in the defensive utilities sector helps to mitigate this deficiency.
Free cash flow
Free cash flow is essentially how much cash has been generated after all costs and can often differ from reported profits. Theoretically, a company generating shedloads of cash is in a better position to reward stakeholders with plump dividends. The figure can be calculated by the following calculation:
Operating profit + depreciation & amortisation – tax – capital expenditure – working capital increase
Centrica punched positive free cash flow of £44m in 2012, falling from £148m in the prior 12-month period. Although operating profit leapt to £2.63bn last year from £1.41bn in 2011, a massive ramp-up in capex costs — to £2.84bn from £1.28bn — weighed on cash flow. An increase in tax, to £1.17bn from £826m, also forced the readout lower.
This ratio is used to gauge the level debt a company carries. Simply put, the higher the amount, the more difficult it may be to generate lucrative dividends for shareholders. It can be calculated using the following calculation:
Short- and long-term debts + pension liabilities – cash & cash equivalents
___________________________________________________________ x 100
Centrica’s gearing ratio came out at 67.7% last year, down from 71.6% in 2011. Although debt rose to £3.12bn from £2.81bn, and the pension liability edged up, the amount of cash on the balance sheet advanced to £931m from £479m. An increase in shareholders’ equity, to £5.93bn from £5.6bn, also caused the gearing ratio to fall.
Buybacks and other spare cash
Centrica is currently carrying out a £500m share repurchase scheme due to its decision not to take part in a new nuclear construction with EDF.
The firm has remained active on the M&A front in recent times, and most notably acquired the oil and gas development and production projects of Statoil and ConocoPhillips for £911m in April last year.
Centrica continues to seek both upstream and downstream investment opportunities across the globe, and just last week announced the purchase of Texas’ Bounce Energy for £30m to boost its exposure to the North American residential energy sector.
Dividends cooking on gas
I believe that Centrica is an excellent pick for those seeking juicy investment income. The company continues to invest heavily to underpin future earnings growth, which I believe should drag shareholder payouts higher.
City forecasters expect 2013’s dividend to produce a yield of 4.7%, far above the 3.3% FTSE 100 average. With a robust balance sheet, Centrica has a solid record of chunky annual dividend increases, and I see no reason for this policy to halt any time soon.
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> Royston does not own shares in Centrica.