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Here’s Why Centrica PLC Is A Better Buy Than National Grid plc

Centrica (LSE: CNA) and National Grid (LSE: NG) (NYSE: NGG.US) are two of the FTSE 100‘s largest utility companies. However, recent concerns about the government’s plans for Centrica have hit the company’s shares.

Indeed, so far this year, Centrica’s shares have underperformed those of National Grid by 22% and the wider FTSE 100 by 16%. For value investors like me, this underperformance has made Centrica look attractive. 

Valuationng

One of the reasons that Centrica now looks so appealing is the company’s valuation. For example, on an enterprise value/earnings before interest, tax, depreciation and amortization, or EV/EBITDA basis, Centrica trades at a multiple of 9.4. 

A EV/EBITDA multiple of 9.4 actually means that Centrica is trading at a 27% discount to the average of its main peers and a 10% discount to National Grid.

On the other hand, National Grid looks expensive. The company is currently trading at a forward P/E of 16.3, a valuation more akin to a growth share than slow-and-steady utility. Moreover, at its current valuation, National Grid is more expensive than it has been at any point during the past decade. 

There is another reason why Centrica looks cheap at its current valuation. You see, some analysts believe that Centrica’s current valuation implies that the company’s UK retail business is worth nothing. Therefore, if the company were to be broken up, the groups individual parts worth be worth more separately and would attract a higher valuation. 

Growth overseas

When it comes down to overseas growth, National Grid is certainly better positioned than Centrica. In particular, National Grid has put in place plans to expand across the globe, ring-fencing £3.5bn for international investment during 2014.

This investment will be focused around the US market where National Grid plans to develop its infrastructure in order to support long-term growth.

Centrica’s also has plans in place for expansion across the pond but the company’s plans are not as aggressive as those of National Grid. The growth plans are centered around Centrica’s US retail business, Direct Energy, which is trying to expand customer numbers.

Still, Centrica is seeking bolt-on acquisitions around the world to boost its international presence, the most recent of which was Ireland’s state-owned Bord Gáis.

Burning issue

So, Centrica’s valuation is attractive, although National Grid’s international expansion plans are impressive. However, there is one thing that concerns me about National Grid; debt. 

There’s no escaping from it, National Grid’s debt pile is the elephant in the room. At the end of 2013 National Grid’s debt totalled £22bn, or 2.2x shareholder equity. In comparison, Centrica’s net debt at the end of 2013 only amounted to 0.8x shareholder equity. 

National Grid’s debt pile cost the company around £1bn to sustain during 2013. Although £1bn is only around a quarter of net income, when interest rates start to rise, National Grid may have a problem on its hands. With rising interest payments, National Grid’s lofty dividend payout could start to come under pressure.

So all in all, Centrica’s low valuation and the company’s lack of debt makes the company a much better investment than National Grid.

Other opportunities 

While National Grid and Centrica may have their differences, they have one thing in common, their impressive dividend yields and defensive nature.

However, as both companies come under increasing pressure from regulators their hefty dividend payouts are no longer gold plated.

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Rupert does not own any share mentioned within this article.