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Should You Buy Centrica PLC After It Slashes Its Dividend By 30%?

Shares in Centrica (LSE: CNA) (NASDAQOTH: CPYYY.US) are down by as much as 9% today after the company reported adjusted operating profit for 2014 that was 35% down on its 2013 level. The main reasons for the fall were a sharp drop in demand during one of the warmest years on record, as well as falling oil prices which hurt the company’s exploration arm.

Furthermore, the owner of British Gas lost 368,000 customers last year and, following a review of its customer numbers, also found that it had overestimated their number by 110,000, meaning it now has 14.8m customers.

Cutbacks

As a result of its disappointing results, Centrica has decided to reduce its dividend by 30%, starting with the final dividend for 2014. It will also cut back on investment and costs, and this seems to be a logical response to the company’s falling bottom line – especially since it has a new management team that has greater licence to make changes than there otherwise would be. Cutbacks should enable Centrica to improve its financial health after being placed on negative watch by S&P and Moody’s recently.

Income Appeal

The cut in dividend means that Centrica now yields approximately 5.2% at its current price of 257p per share. While this is less than the market was expecting, it remains a very appealing income stock that has a much higher yield than the majority of its index peers and, after the understandable disappointment of investors has subsided (which could take several days), Centrica could see its share price firm up once the market realises that the dividend cut is a sensible response to what has been a challenging year for the business.

Looking Ahead

Clearly, the next few months will be highly uncertain for Centrica. A change in government could cause market sentiment in the stock to deteriorate significantly, with a Labour government promising to be much tougher on domestic energy suppliers than the current government has been. In addition, further weakness in the price of oil could cause substantial impairments to assets in its exploration arm and also hurt profitability.

However, even taking these risks into account, Centrica still appears to be worth buying at the present time. Not only does it offer a superb yield, it also trades at a valuation that seems to take such risks into account. For example, Centrica has a price to earnings (P/E) ratio of 13.4 which, at a time when the FTSE 100 has a P/E ratio of around 15.9, seems to indicate good value. As such, and while its share price could come under further pressure in the short run, it remains a very appealing long term buy.

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Peter Stephens owns shares of Centrica. The Motley Fool UK has recommended Centrica. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.