Forget the Centrica share price, I’d buy this 4.8% yield instead

Centrica plc (LON: CNA) might look attractive but its long-term outlook is bleak, says Rupert Hargreaves.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

At the time of writing, shares in British Gas owner Centrica (LSE: CNA) yield a highly attractive 8.9%, according to City forecasts. This is almost double the FTSE 100 average of 4.8%.

But while this market-beating dividend yield might look attractive, I’m not a buyer of the Centrica share price. I think there are plenty of other dividend stocks out there with brighter outlooks. Today, I’m looking at one of these opportunities.

Losing money

Shares in Centrica might look attractive today, but the company’s record of creating value for investors is, quite simply, terrible. 

Over the past 10 years, shares in the company have returned just 0.25% per annum, including dividends, which implies you would have been better off keeping your money in a savings account rather than owning the shares. Over the past five years, Centrica’s performance is even worse. Including dividends, the stock has returned -10.5% per annum since January 2014 (although it has outperformed in 2018). 

By comparison, the FTSE 100 has returned 3.9% per annum for investors (over the past decade, the UK’s leading blue-chip index has returned 8.3% per annum).

Performance issue 

Centrica has been dogged by a series of performance issues over the past 10 years, and it doesn’t look as if it’s going to get any easier for the company anytime soon. The government’s price cap is almost certain to hit profitability, and the business is losing hundreds of thousands of customers to competitors. 

Analysts expect Centrica’s earnings per share (EPS) to drop a staggering 51% for 2018 to 12.3p. Only a small recovery is expected in 2019. Based on these figures, even though the shares have declined nearly 50% over the past two years, they still don’t look particularly cheap. Indeed, at the time of writing, shares in Centrica are trading at a forward P/E of 11.

A better buy? 

Considering the above, I’m in no rush to buy Centrica. The company’s yield might look attractive, but I think the shares could fall further if earnings continue to deteriorate.

With this being the case, I reckon Drax (LSE: DRX) could be a better income buy. Shares in this power station owner yield 4.8%, according to City forecasts for 2019, which looks disappointing compared to Centrica’s 8.9% distribution. 

However, analysts have pencilled in EPS growth of 183% for 2019, as the firm’s recent acquisition of a portfolio of power generation assets from the Scottish Power Generation Group starts to yield results.

Predictable business

I reckon Drax is also a better investment than Centrica because the company doesn’t have to compete for customers. Power generation is a relatively dull and commoditised business, and demand should only grow going forward.

What’s more, Drax doesn’t have to worry about enticing retail customers and dealing with complaints. The enterprise also has more scope to expand, because setting up power plants is highly regulated and costly, so Drax has few natural competitors. By comparison, setting up an retail supply energy business to compete with Centrica is relatively easy.

That’s why I think Drax is the better income buy, despite its lower yield. The company has more scope to grow, and I reckon its dividend is more sustainable as a result.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Rupert Hargreaves owns no share 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.

More on Investing Articles

Investing Articles

£10,000 invested in Games Workshop shares 5 years ago is now worth…

Despite inflation, higher interest rates, and a cost of living crisis, Games Workshop shares have gone from strength to strength…

Read more »

Investing Articles

How much in a Stocks and Shares ISA could earn me £500 of passive income each month?

Christopher Ruane does the maths and explains how he's trying to generate hundreds of pounds per month in passive income…

Read more »

Investing Articles

Prediction: 2 UK shares that could outperform Rolls-Royce between now and 2030

Away from the FTSE 100 and the FTSE 250, Stephen Wright thinks there are some UK shares with outstanding growth…

Read more »

Investing Articles

Can easyJet soar like the Rolls-Royce share price?

Harvey Jones is looking for FTSE 100 stocks that can match the success of the Rolls-Royce share price. Budget carrier…

Read more »

Investing Articles

Is there any growth potential left in Tesla stock?

Tesla stock has shot up 85% in less than three months. Christopher Ruane shares his take on the firm's valuation…

Read more »

Runner standing at the starting point with 2025 year for starting in new year 2025 to achieve business planing and success concept.
Investing Articles

Can Taylor Wimpey rocket like the IAG share price?

The IAG share price smashed the FTSE 100 last year but Harvey Jones thinks it may struggle to repeat that…

Read more »

Runner standing at the starting point with 2025 year for starting in new year 2025 to achieve business planing and success concept.
Investing Articles

Here’s how a stock market beginner could get going in 2025 with £260!

Christopher Ruane explains how a stock market novice could start buying shares for the first time this year with just…

Read more »

Investing Articles

Games Workshop share price falters on half-year results as fears of US tariffs loom

The Games Workshop share price suffered a dip this morning after releasing interim results. Is there more room for growth…

Read more »