Centrica (LSE: CNA) offers a tempting 5.5% yield that may well be enough to persuade many investors to overlook the 20% decline in the firm’s share price over the last year.
After all, most investors own Centrica for income — so topping up now could be a wise move.
However, Centrica’s reputation and profits have taken a battering from the twin forces of political interference and the unpredictable British weather over the last year — and both factors could deliver more surprises over the next 12 months.
Is now the right time to buy Centrica shares?
Cheap — or not?
Centrica’s earnings are more volatile than many utilities, as its exposure to oil and gas exploration and production combine with its utility profits to create considerable year-on-year fluctuations.
To smooth out the peaks and troughs and get an idea of the firm’s valuation, I’ve averaged Centrica’s historic and forecast earnings over several years:
|
P/E ratio |
Current value |
|
P/E using 5-year average adjusted earnings per share |
12.9 |
|
2-year average forecast P/E |
14.1 |
Source: Company reports, consensus forecasts
Centrica’s forecast P/E is higher than its historical P/E, which tells us that City analysts expect the firm’s earnings per share to be lower over the next couple of years than they have been in recent years.
Adjusted earnings per share are expected to fall sharply from 26.6p in 2013 to just 21.4p this year, before recovering to around 24p in 2015. The big risk for investors is that this will threaten the affordability of Centrica’s dividend, which is only expected to be covered around 1.2 times by earnings this year.
What about the fundamentals?
All companies experience lean years from time to time — it’s often more important to focus on long-term trends, to see whether they support the investment case for the stock:
|
Metric |
5-year compound average growth rate |
|
Revenue |
+3.9% |
|
Adjusted operating profit |
+7.7% |
|
Post-tax profit |
+2.9% |
|
Dividend |
+5.8% |
Source: Company reports
In Centrica’s case, we can see that the firm’s dividend payout has risen at twice the average rate of the firm’s post-tax profits, suggesting that the dividend accounts for a larger share of earnings than it did five years ago.
As the dividend is meant to be paid from post-tax profits, this could eventually become a problem, although current City forecasts suggest that Centrica will increase its dividend by around 3% this year and next, despite its weak profit outlook.
What’s the verdict?
In my view, the upside and downside risks facing Centrica are fairly evenly balanced, so I’d rate the shares a hold at their current price of 320p.