Centrica (LSE: CNA) shares sank by 8% on Thursday morning, after the British Gas owner announced a 30% cut to its final dividend payment for 2014, slashing the full-year payout from 17p to 13.5p.
It was already clear that Centrica’s dividend was under pressure, and with hindsight it was likely that new chief executive Iain Conn would take the opportunity of cutting the payout at the start of his tenure.
In this article, I’ll explain why Centrica needed to cut its dividend, and give my view on whether energy utility peers SSE (LSE: SSE) and National Grid (LSE: NG) (NYSE: NGG.US) are likely to do the same.
Why did Centrica cut?
Centrica’s profits have been hit by a triple whammy of falling oil prices, weak demand for gas due to mild weather, and falling customer numbers.
Operating profits fell heavily in all of Centrica’s divisions last year, leaving the firm’s total adjusted operating profit down by 35%, at £1.8bn. Net cash flow from operating activities fell by 58% from £2.9bn to £1.2bn, making last year’s dividend — which cost around £860m — look too generous.
Despite this, many investors will have been surprised — in Centrica’s November interim update, the firm said: “In line with our stated policy, we expect to deliver real dividend growth this year.”
Will SSE and NG cut, too?
National Grid has promised that its dividend growth will match inflation for the foreseeable future. I don’t believe the grid operator will make a cut, as its costs and income are far more stable than those of Centrica.
SSE has also reiterated its plans for dividend growth in-line with RPI inflation, most recently in its third-quarter statement in January.
However, I think there is a risk that SSE’s payout might be cut, most likely next year.
Although the firm’s finances are not as stretched as those of Centrica, SSE’s cash flow is likely to will be tight this year, and earnings cover for the dividend will fall below the firm’s target level of 1.5.
SSE has already admitted that the outlook for earnings growth is uncertain over the next two years, and in my view, a cut similar to Centrica’s 30% reduction could make sense, and would bring the firm’s prospective yield into line with those of Centrica and National Grid.
Buy ahead of the election?
Uncertainty about the political environment utilities will face could cause share prices to fall ahead of May’s general election. This could even be a good buying opportunity.