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3 reasons why I think Centrica will slash dividends again

It can be mighty tempting to hold onto shares that have nursed huge losses rather than to cut them adrift and endure the pain. No-one likes to admit that they’ve made a crushing mistake, after all.

That said, I think those hanging onto Centrica (LSE: CNA) in the hope of a share price recovery could be considered gluttons for punishment. Its share price remains in freefall, down 35% since the turn of the year, and with no possible catalysts in sight that could help it snap higher.

On the plus side for investors, the company’s resisted the temptation to hack back dividends since it last reduced shareholder payouts back in 2015. A quick glance at City forecasts I reckon the FTSE 100 firm’s about to wield the scythe once again, though, and to reduce the 2019 full-year reward to 7.5p per share, from the 12p paid over the past several years.

I believe, though, the utilities giant may be forced to dial back payments even greater than those suggested by the number-crunchers. And here are three reasons why:

1. Poor dividend cover

Heavy annual profits falls have been a constant feature of Centrica over the past half a decade, and it appears for all the world that another painful drop is in store in 2019. Indeed, City analysts are expecting earnings to contract by a staggering 27%.

What this means is the 7.5p per share dividend they’re predicting is barely covered at just 1.1 times. This falls some way below the widely-regarded safety benchmark of 2 times or above, and leaves the predicted payout looking a tad fragile at best.

2. The battered balance sheet

It’s not as if Centrica has the financial clout to mitigate for this paltry coverage. It doesn’t matter that the business has delivered £900m of savings since 2015 through an intense cost-efficiency programme that’s seen it cut jobs all over the business and double-down on digitalisation… the balance sheet still keeps on flashing red.

Free cash flow for instance, one of those most critical check on a company’s financial health, continues to slide at the energy giant. In 2018, this dropped to a shade over £1.8bn from £2.1bn a year earlier. Meanwhile, net debt grew by £50m year-on-year to around £2.7bn. But this rise is nothing compared to what’s coming down the tracks — Centrica predicts its debt will range £3bn-£3.5bn by the close of this year.

3. A worsening trading outlook

Even if the energy giant had the capacity to pay the dividend expected by City boffins, would it actually be minded to do so given the prospect that profits will keep diving beyond the current year?

Latest financials showed its British Gas retail division lost almost a quarter of a million more accounts between January and April. Meanwhile, the latest data from trade body Energy UK showed the switching frenzy among households is far from over, suggesting that much more pain is around the corner. Some 2.5m people changed supplier in the first five months of 2019, up 14% year-on-year.

As far as I’m concerned, you can keep Centrica’s bulging 8.3% dividend yield. The risks to dividends in the near term and beyond are clearly far too great, and I’d be much happier to go income hunting elsewhere.

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Royston Wild 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.