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Centrica PLC’s Fall Makes It A Better Buy Than SSE PLC and National Grid plc Now

When Centrica (LSE: CNA)(NASDAQOTH: CPYYY.US) slashed its 2014 full-year dividend by 21%, investors were shocked. After all, utilities companies are the safest on the planet and should never reduce their annual cash payouts, isn’t that so?

Well, the thing is, these firms pay out a very large portion of their earnings as dividends — Centrica’s 2013 dividend was covered 1.6 times by earnings, and that’s high for the sector. There’s very little safety margin there, and when a dividend cut is necessary it can lead to an emotional over-reaction. We saw the same with insurance companies, where dividend cuts that were badly needed to restore the long-term health of the sector led to short-term crashes with people selling out at exactly the wrong time.

More cash needed

Centrica had decided that its cash situation needed to be beefed up a bit, and in the face of falling profits the only thing it could do was reduce the amount of the stuff it hands back to shareholders.

Full year results from SSE (LSE: SSE) won’t be with us until 20 May, with figures from National Grid (LSE: NG) due a day later — their year-ends are three months later than Centrica’s at the end of March. SSE’s current dividend forecast suggests a yield of 5.8% with the shares priced at 1,572p, and that would be covered only around 1.3 times by predicted earnings — quite a bit less than Centrica’s 2013 dividend cover.

SSE has faced squeezed revenue as well, partly from regulatory pressure, and it’s also in a bit of a tight cash situation with net debt having risen at the halfway stage in September to £6.1bn, from £5.9bn at its previous year end. And there was only £244m in cash and equivalents on the books.

Divi cut?

Could SSE reduce its final dividend? I think it could, and it would now avoid the stigma of being the first to do so — and that would almost certainly trigger a share price fall.

Over at NG there’s a 15% fall in EPS forecast, and while that’s not as big as the drop Centrica has just reported, it will surely put pressure on the firm’s dividend — expected to yield 4.8% on a price of 246p. And it’s only set to be covered around 1.3 times again, just like SSE’s.

NG’s first-half net debt was up too, by £554m to £21.7bn — and though that’s not a big percentage rise, coupled with falling EPS it could lead the company to retain more cash this year. Against that, NG has restated its intention to keep dividends growing in line with inflation, and that makes me feel we’re less likely to see a dividend cut.

Oversold?

But with Centrica’s shares down 13% since the dividend cut was announced to 245p, and down 17.5% since their recent high earlier this month, I think they’re oversold now. We’re looking at a forecast P/E of well under 13 for the current year, and even after the cut the dividend is still likely to yield over 5% — and recent brokers’ updates have set significantly higher price targets for the shares, of between 270p and 325p. I rate Centrica a Buy.

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Alan Oscroft has no position in any shares mentioned. 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.