At first glance, shares in British Gas owner Centrica (LSE: CNA) look like an excellent income investment. The stock currently supports a dividend yield of 7%, and the figures suggest the distribution is covered 1.4 times by earnings per share for 2019.
But, as investors found out a few months ago, Centrica’s earnings can be highly volatile. The company was forced to slash its dividend by 60% earlier this year. That followed six months of operational problems, including unplanned outages at UK nuclear power plants in which Centrica holds stakes.
Furthermore, it looks as if the business is struggling to generate enough cash to invest in its operations and return money to shareholders.
Since 2015, Centrica has divested stakes in wind farms and big power stations as well as taking an axe to costs. It’s also planning to sell its 20% holding in the UK’s operational nuclear power plants and its Spirit Energy business.
Following these divestments, Centrica is now 40% smaller (on a shareholder equity basis) than it was in 2013.
The problem is, the group cannot continue to sell assets forever. Sooner or later the company will run out of bits to sell. It’s difficult to tell what will happen in this scenario, but I think another dividend cut is highly likely.
The situation is made worse by the fact Centrica is just not growing. Revenues have hardly budged since 2015 and two new divisions, Connected Home and Distributed Energy and Power, which were supposed to transform the group and generate £2bn in revenue by 2022, have fallen flat.
So, considering all of the above, I think shares in Centrica could fall further over the next few years. For that reason, I’d advise staying away.
A growth champion
A better place for your money could be DCC (LSE: DCC). Unlike Centrica, DCC knows how to grow. Over the past six years, the company’s net profit has grown at a compound annual rate of 16.6%, and the dividend to shareholders has grown at 12.5% per annum.
As Centrica has shrunk by 40%, DCC has more than doubled its shareholder equity through a combination of bolt-on acquisitions and the reinvestment of profits.
Considering this track record, I think the stock would be a much better income investment than Centrica. While the dividend yield is just 2% at the time of writing, it’s covered 2.5 times earnings per share, and, more importantly, DCC remains in growth mode.
As the company continues to invest in its operations over the next few years, City analysts are expecting earnings to jump by more than 20%, freeing up more capital to invest back in the business and return to investors.
According to my calculations, with another five years of 12.5% per annum dividend growth, the yield could hit 3.5% by 2024, and 6.4% after 10 years. On that basis, I think DCC has much better prospects than Centrica as a long-term income investment.
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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.
Motley Fool UK 2019