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Here’s Why National Grid plc And Centrica PLC Could Be The Perfect Combination

You can’t go wrong with National Grid (LSE: NG), in my opinion. As manager of the UK’s power grid, unless the country suddenly stops using electricity, the company will always be able to generate income. 

What’s more, National Grid is run by an extremely astute management team, which is currently trying to expand the group’s international presence and grow earnings. 

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On the other hand, Centrica’s (LSE: CNA) management has let shareholders down over the past five years. A misguided expansion into the oil and gas production business has cost the company dearly and claimed the head of former CEO Sam Laidlaw. 

Laidlaw has now been replaced by Iain Conn, who has started a shake-up of the UK-based energy group. Capital spending is being drastically reduced, and the group is set to refocus its growth efforts on customer-facing activities. Management has decided that the company will divert £1.5bn of capital from its oil and gas business towards customer-facing operations such as British Gas. Moreover, under the guidance of Iain Conn, Centrica’s day-to-day group costs will fall by £750m between 2015 and 2020. 

So, Centrica is trying to make up for past mistakes, but this will take time. However, as Centrica’s recovery get under way, investors stand to profit as the company returns to growth. And by including both Centrica and National Grid in their portfolios, investors will benefit from both capital appreciation and income. 

Income play

National Grid has proven over the past decades that it’s a stronger company than Centrica. 

For the past five years, National Grid’s revenue has grown at a steady rate of around 1% per annum, which isn’t anything to get excited about. Nevertheless, National Grid’s management has been cutting costs drastically over the same period. While the company’s revenue has stayed relatively constant since 2010, net income has jumped by 81%.

In contrast, over the past five years Centrica’s revenue has increased by 31% but net income has more than halved. 

And National Grid’s growing bottom line has enabled the company to increase its already hefty dividend payout steadily over the years. Since 2011, National Grid has increased its annual payout by around 5% per annum. The shares currently support a dividend yield of 5.1%, and the payout is covered 1.4 times by earnings per share. 

Over the past five years, after including dividends, National Grid’s shares have returned 105% for investors. Centrica’s shares have returned -5%. 

Capital growth 

Centrica’s may have disappointed over the past five years but now that the company has changed its strategy, it looks as if shareholder returns could start to improve. 

Indeed, I believe management’s decision to scale back Centrica’s upstream business is a great move for the company. Oil & gas production is a notoriously volatile and capital intensive business. Focusing on the more predictable customer-facing side of the business should put Centrica back on the path to long-term sustainable growth. Also, Centrica’s focus on the more predictable customer side of the business should help the company maintain its dividend payout at present levels.  

The company currently supports a dividend yield of 5.9%. The payout is now covered one-and-a-half times by earnings per share.

The best income investment 

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Rupert Hargreaves 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.