The Risks Of Investing In Centrica PLC

Today I am highlighting what you need to know before investing in Centrica (LSE: CNA).

Political pressure poised to heat up

The colossal battle between the country’s major energy providers and regulators over the issue of rising bills has been rolling for donkeys’ years now. But since the onset of the 2008/2009 financial crisis hammered household budgets, the environment has become much more difficult for Centrica and its peers to operate, a situation which could deliver a hammer-blow to future earnings.

Labour leader Ed Miliband first sounded the klaxon last September when he called for a multi-year energy tariff freeze, and since then gasringCentrica and its peers have been referred to the competition watchdog and touted as potential break-up candidates amid allegations of exorbitant profits.

The country’s ‘Big Six’ energy providers have all seen the bottom line whacked hard in a bid to curry favour with the ruling classes and hold off on implementing fresh price rises. Indeed, Centrica itself noted in its latest financial update that “the first half of the year has seen challenging market conditions across the Group, both as a result of the weather and reflecting the wider political environment”.

Operating profit at the company’s British Gas subsidiary collapsed 20% during January-June to £455m, and the business expects the average bill to fall 7% on-year in 2014. And with politicians expected to up the rhetoric ahead of next year’s political run-off, combined with intensifying regulatory scrutiny, the business may find it nigh-on impossible to jump-start its revenues prospects before the election and potentially beyond.

Dividend growth under threat?

And with earnings expected to come under pressure during the medium term at least, Centrica’s dividend outlook can be considered dicey at best in my opinion. Shrugging off an anticipated 17% earnings slide this year, the energy play is still anticipated to lift the full-year payout to 17.6p per share.

However, the dividend is covered by earnings just 1.3 times for this year, well below the minimum security benchmark of 2 times. A 10% earnings rebound in 2015 is expected to prompt a further 3% dividend advance to 18.1p, although dividend cover remains flat from the current year.

Centrica last month took time to “reaffirm our commitment to delivering real dividend growth”, as well as to underline its commitment to its £420m share buyback scheme — just over £210m worth of equity has been repurchased. But given the increasingly-difficult trading environment, Centrica’s vow to keep rewarding shareholders with both buybacks and meaty dividend growth could come increasingly under the cosh.

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Royston Wild has no position in any shares mentioned. The Motley Fool has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.