Centrica (LSE: CNA) used to be one of the FTSE 100’s top income stocks, a reputation that management has tried to maintain for as long as possible. However, I believe it is only a matter of time before the owner of British Gas is forced to cut its dividend payout once again.
Time to sell?
Centrica last cut its dividend in 2015 (fiscal 2014) when a combination of factors forced the group’s hand. Falling oil prices, rising costs, increased political scrutiny, and a high level of debt meant management had little choice but to reign in distributions to investors. The payout dropped from 17p in 2013, to 13.4p in 2014, before dropping again to 12p for 2015.
At the time, the company believed reducing the distribution to 12p would be enough to lower debt and restore investor confidence. After a few years at this rate, the market believed growth would return. After all, for fiscal 2015 analysts had pencilled in earnings per share (EPS) of at least 20p (23p was reported), leaving plenty of room for dividend growth in the years ahead.
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Unfortunately since 2013, the group’s normalised earnings per share have shrunk by nearly 50%. The payout is now only just covered by EPS (based on fiscal 2017 numbers).
Going forward, City analysts are not expecting a sudden recovery. For 2018, EPS of 12.8 are forecast, but these numbers don’t take into account any possible customer attrition for when the government’s price cap on standard variable tariffs (SVT) arrives at the end of 2018.
Considering all of the above, I reckon the company is today in a similar position to the one it was in towards the end of 2014. Centrica is facing pressure from all sides and dividend cut may be the only choice management has to restore confidence.
With this being a case, I’m avoiding Centrica’s 8.1% dividend yield.
A better growth buy
Centrica’s future is uncertain, but one company I’m more positive on the outlook for is Polypipe (LSE: PLP). Manufacturer of plastic piping systems, Polypipe’s business is so boring it is unlikely to ever attract the same (mostly negative) publicity as Centrica. I reckon this makes the shares much more attractive because management can focus on growth, rather than PR.
And over the past five years, Polypipe has produced some impressive growth. Since 2012, earnings per share have grown at a compound annual rate of 19% as net profit has more than doubled. Acquisitions have formed a significant part of the growth strategy. For example, today Polypipe announced the acquisition of Permavoid Limited, a specialist designer and supplier of surface water management solutions.
Analysts believe organic growth, coupled with a steady stream of bolt-on acquisitions, will help Polypipe grow EPS around 10% this year, and 6% in 2019. Although I wouldn’t rule out upward revisions to these numbers as they currently exclude any future deals.
For a company with a growth record like Polypipe, I would expect the shares to trade at a premium valuation. However, they’re changing hands at just 13 times forward earnings which, to my mind, undervalues the business. A dividend yield of 3.2% is also on offer, covered 2.4 times by EPS.
So, if you’re looking for a replacement for Centrica in your portfolio, Polypipe could be a good candidate.
