Today I’m looking at two potential high-yield bargains for 2017. Both companies operate in the same sector but one has seen its value falling in recent months and the other is losing customers. But they still offer yields of between 4.8% and 5.8%, backed by strong cash flows and regulated incomes.
Special dividend + growth focus
Last week, National Grid plc (LSE: NG) announced the sales of a majority stake in its UK gas distribution business. The group has sold a 61% stake in this business for a total of £4.4bn.
National Grid plans to return £4bn of this payment to shareholders. At least 75% of this amount is expected to be returned via a special dividend during the second quarter of 2017. I estimate that this should be worth about 80p per share. The remaining £1bn is likely to be used to fund share buybacks.
National Grid will retain a 31% stake in the UK gas distribution business. However, the sale is intended to allow the firm to focus on areas with greater growth potential, such as its regulated utility business in North America.
For UK investors, I believe National Grid has a number of attractions. The firm’s UK operations and pricing rarely come under political scrutiny, as they don’t deal directly with consumers. Exposure to commodity prices is also low, resulting in more stable earnings.
The firm intends to increase its ordinary dividend in line with RPI inflation for the foreseeable future. Some economists believe inflation may soon start to rise. If it does, then National Grid’s 4.8% yield could become very attractive indeed.
On the other hand, National Grid’s shares have fallen by 15% over the last three months. Despite this, the shares’ dividend yield is still one of the lowest in the utility sector. If bond prices keep falling, utility stocks such as National Grid could have further to fall.
Overall, I think National Grid remains a strong hold for income investors. However, I might wait a little longer before buying more.
A stronger alternative?
One potential alternative to National Grid is Centrica (LSE: CNA). Although Centrica also has a North American business, the group’s UK operations revolve around its British Gas business and its oil and gas production operations.
Centrica is more heavily exposed to commodity price movements than National Grid. But with oil prices now starting to rise decisively, I think this could be a good thing. Centrica should enjoy a solid boost to profits and cash flow from higher oil prices.
Management seems confident. In Centrica’s half-year results, published in July — before the price of oil started to rise — the company said that full-year adjusted operating cash flow should “exceed £2bn”. Net debt at the end of the first half was £3.8bn, 23% lower than at the same point in 2015.
My main concern with Centrica is that the British Gas business will continue to lose customers. The number of customer accounts fell by 3% during the first half of the year, contributing to a 6% drop in adjusted operating profit for this part of the business.
Centrica says it’s taking steps to address this decline. Broker consensus forecasts are suggesting that the stock is a hold at the moment. In my view, this could be unduly pessimistic. I reckon Centrica’s 5.6% forecast yield could be worth considering, for income investors.
