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4 reasons why I think FTSE 100 stock Centrica is a dividend disaster

There’s plenty of investors still prepared to buy Centrica (LSE: CNA) even though every man and his dog expects the dividend to be hacked down again in 2019. Quite the mystery, in my book.

These are the facts. City analysts forecast profits will fall by double-digit percentages again this year and the FTSE 100 energy giant will reduce the annual dividend to 10.5p per share, a move that would represent the sixth year in a row in which it’s failed to raise the payout, and the third cut in that period.

Speculation abounds that Centrica won’t be able to meet even this vastly-reduced estimate, though (it paid another 12p per share dividend in 2018), and therefore its 10% forward yield should be ignored. And there’s plenty of reason to listen to the naysayers, beginning with…

Poor dividend cover

For 2019, the predicted dividend actually outpaces anticipated profits of 9.8p per share. The rule of thumb is that share pickers should seek out stocks where estimated payouts are covered at least 2 times over by expected profits, levels which Centrica can clearly only dream of.

A battered balance sheet

Some stocks can get away with poor dividend cover, but Centrica isn’t one of these. Years of persistent earnings pressure leaves the balance sheet in one hell of a state. And you shouldn’t just take my word for it, this month Standard and Poor’s cut the company’s long-term credit rating to BBB (with a stable outlook) from BBB+ (with a negative outlook).

Not a surprise given the amount of net debt on the energy giant’s balance sheet. This rose to £2.66bn as of the end of 2018, from £2.6bn 12 months earlier. It’s also tipped to rise possibly as high as £3.5bn in 2019, despite ongoing divestments and self-help measures to cut the cost base.

Switching numbers hot up

The country’s Top Six energy suppliers are stuck in a no-win situation when it comes to price hikes. Do they sacrifice profitability and freeze prices to protect their customer bases, or raise tariffs and haemorrhage clients to low-cost independent suppliers?

Centrica and its peers remain committed to the latter but may have to change course as the number of households switching supplier is accelerating. Indeed, Ofgem’s decision to increase the price cap in April saw more people change supplier in the first few months of 2019, and recent trading figures from Moneysupermarket illustrated this perfectly. Sales at its Home Services division boomed 70% in the three months to March on the back of increased switching activity.

Mild weather

Great for the great British public, but the warmer-than-usual weather at the start of 2019 (and the baking temperatures in April) is more problematic for the likes of Centrica, though. Milder temperatures lessen the need for energy, needless to say, throwing another spanner in the works for the Footsie firm and its 2019 earnings forecasts. If last year was anything to go by, we may see more of the same in the months ahead, adding more pressure to current profits and dividend projections.

The Footsie’s jam-packed with income stocks that are in great shape to pay big dividends in 2019 and beyond. Given the broad range of problems Centrica faces, I’m afraid it can’t be considered one of these. For this reason, I plan to keep avoiding it like the plague. 

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Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has recommended Moneysupermarket.com. 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.