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Should investors in Footsie income stalwart Centrica prepare for a dividend cut?

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The value of shares in British Gas owner and FTSE 100 member Centrica (LSE: CNA) have pretty much halved in value over the last year. Based on its latest full-year numbers (and despite the market’s initial reaction to them), it’s hard to see anything but more pain ahead for its owners. What’s more, I strongly suspect the blue-chip’s coveted dividend will be slashed in time.

“Weak” second half

Having released a shock profit warning last November, today’s numbers were never expected to be impressive. That said, the scale and speed of Centrica’s decline are concerning.

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As a result of significantly reduced profit in its Business energy supply units, adjusted operating profits fell 17% (from £1.5bn in 2016) to £1.25bn in 2017. Earnings before interest, tax, depreciation and amortisation (EBITDA) dropped 9% with adjusted operating cash flow tanking 23% as a result.

Reflecting on today’s figures, CEO Iain Conn stated that Centrica’s financial performance in the second half of the financial year had been “weak“. He went on to remark that political uncertainty, the likelihood of increased regulation in the UK, the departure of customers to competitors and poor performance in North America had “created material uncertainty” around the company leading to “a very poor shareholder experience“. It’s hard to disagree with that.

Looking ahead, Centrica now plans to increase its cost saving targets to £1.25bn per annum (from the original £500m) by 2020. And 4000 more jobs will go, mostly from its UK energy supply business. Perhaps understandably, the company has also reassured investors that it does not intend to make any major acquisitions.

The biggest question on many shareholders’ lips, however, is surely what will happen to the company’s payouts if poor performance continues?

Ready for the chop?

Today’s full-year dividend of 12p per share leaves the company offering a worryingly high yield of 8.9%.

While some may take heart from Centrica’s desire to maintain the dividend at this level, it’s worth pointing out that this is dependent on the Windsor-based business meeting its cash flow and debt targets. According to today’s statement, these are between £2.1bn and £2.3bn for the former and within a range of £2.25bn to £3.25bn for the latter. Capital expenditure also needs to remain below £1.2bn. 

Given the very real possibility of the proposed cap on standard energy tariffs coming into force, it’s likely that these numbers will need to be revised at some point in 2018. If a dividend cut does come, expect the share price to react accordingly. 

Buyer beware

Centrica’s woes are yet another reminder of the need to check whether a company’s dividend policy is realistic. Aside from avoiding sky-high yields and looking at the extent to which payouts are covered by profits, it’s also important to scrutinise by how much dividends have grown over the last few years (if at all). The fact that Centrica’s dividend hasn’t budged since 2015 says a lot. Regular hikes to the dividend imply a company in rude health. A stagnant dividend suggests the opposite.

Holding a diversified portfolio, regardless of your investing strategy, can also be a wealth-saver. With the exception of a complete meltdown in the markets, you can be assured that your other holdings will help mitigate any losses from one or two nightmare holdings.  As things stand, Centrica’s is surely an example of the latter.

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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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