After falling in value by nearly 50% over the past 24 months, shares in Centrica (LSE: CNA) now support a dividend yield of 8.8%, which, I’ll be honest, looks quite attractive at first glance.
However, I’m not prepared to take this distribution at face value. If we dig deeper into the numbers, it becomes clear that Centrica’s current dividend is living on borrowed time.
Cash crunch
A few weeks ago, City broker Jefferies said that Centrica’s dividend is “hanging by a thread,” as the company is struggling to deal with the whole selection of operational problems and volatile commodity prices.
According to the broker, Centrica’s earnings per share (EPS) could decline by 8% in 2019, based on current trends. This is the base case scenario. Jefferies goes on to say that if UK power prices fall a further 20%, the owner of British Gas would see its credit rating downgraded, increasing the cost of borrowing for the group, and possibly forcing management to sell-off the company’s nuclear business.
Personally, I wouldn’t invest in a business with such an uncertain outlook, and I think you should do the same. There’s very little good news around for the utility industry right now and, as Centrica’s dividend is only just covered by EPS, even a slight decline in profitability could force management to slash the payout. For this reason, I’m staying away.
Cash flow positive
On the other hand, I’m more optimistic about the outlook for consultancy group RPS (LSE: RPS).
With a dividend yield of 7.1%, shares in this company immediately look attractive from an income perspective. What’s more, unlike Centrica, which operates in a heavily regulated industry, RPS doesn’t. So the business has more control over its future and isn’t subject to government energy price caps or volatile wholesale fuel prices.
RPS is also internationally diversified. Today, the company announced the acquisition of Corview, an Australian-based transport advisory consultancy for a total sum of £17.8m, payable in cash. Management hopes the deal will improve the group’s presence Down Under, and it seems to be a good fit for the business.
Alongside today’s acquisition announcement, RPS issued a trading update for full-year 2018. Trading is in line with City expectations, although slightly down on last year. Profit, before tax and amortisation, is predicted to be 7% lower year-on-year.
Still, despite this decline, cash generation remains strong. That’s why I’m interested because cash generation is generally a better predictor of dividend sustainability than earnings growth. According to my calculations, the company generated free cash flow of around £30m for 2018. That’s based on the fact that net debt fell approximately £8m during the year, and an assumed total dividend cost of £22m (based on 2017s figures).
These figures suggest to me that the firm has plenty of cash headroom to sustain its current dividend. Further, right now shares in RPS are dealing at an attractive forward P/E of just 8.8. I think this undemanding price is worth paying for RPS’s income potential.
