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Are you tempted by the 8% yield on the Centrica share price? Here’s what you need to know

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With its share price trading at levels not seen since 2003, Centrica (LSE: CNA) stock offers a forecast dividend yield of 8.2%. It’s a tempting prospect. But we need to know whether this payout can be sustained.

Put a cap on it

As a Centrica shareholder myself, I think there’s a good chance that the payout will be held. Today, I want to explain why.

One of the factors putting pressure on utility share prices over the last year has been the government’s planned price cap. Details of the cap were published earlier this month and, in short, about 11m households are expected to save an average of £75 each year. This implies a loss for utility sector revenue of about £825m.

Centrica’s share price rose after this news, suggesting it was no worse than expected. Management guidance has also remained unchanged, so far.

Still a cash machine

At the core of forecasts for Centrica’s dividend is the group’s cash flow guidance. Management expect to generate adjusted operating cash flow of between £2.1bn and £2.3bn this year. To help achieve this, cost savings of £200m are planned.

Capital expenditure for the year is expected to be limited to £1.1bn. The difference between operating cash flow and capex gives us an adjusted free cash flow figure of around £1bn, perhaps a little more.

Once interest costs of about £300m have been paid, this should leave just enough surplus cash to cover the cost of the dividend, which I estimate at about £675m.

In my view, this suggests the dividend will remain safe this year, and probably next year too. But earnings forecasts for 2019 are flat. In my view, a return to growth will be required to support the current payout beyond 2019.

This situation isn’t without risk, as my colleague Rupert Hargreaves explains. But I believe a turnaround is still likely and rate the shares as a buy.

Is this 8% yield safer than Centrica?

Another stock offering a forecast dividend yield of 8% is legal services and personal injury specialist NAHL Group (LSE: NAH), which runs the National Accident Helpline business, among others.

This £55m firm has been hit by regulatory changes in recent years and forced to change its business model. As a result, the group’s dividend has already been cut from a high of 19.1p per share in 2016 to a forecast level of 9.5p per share this year. This gives a forecast yield of 7.8%.

Today’s half-year results confirmed that the interim dividend will be cut from 5.3p to 3.2p. This seems to match up with the full-year forecasts, but the group’s share price is 4% lower at the time of writing.

I suspect investors are concerned that this business is still struggling to generate any growth. Today’s figures show revenue unchanged at £24.9m, and pre-tax profit unchanged at £5.3m.

However, net debt has risen by almost 50% to £17.4m over the last year. In my view, we need to see some growth as a result of this spending — otherwise this debt burden could become problematic.

What I’d buy

I believe the best company for investors in this sector is rival Redde, about which I wrote recently.

I’m not yet convinced by the turnaround at NAHL. In my view, there’s still a fair risk that growth will disappoint and another dividend cut will be necessary. I’m going to steer clear for now.

Buy-And-Hold Investing

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Roland Head owns shares of Centrica. 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.