Centrica plc's 8%+ yield is too hot to ignore

Pity the poor Centrica(LSE: CNA) investor who has endured four cold years since the utility's share price peaked at 400p in September 2013. The climate just gets chillier, with the stock down another 30% in the last six months to trade at a dismal 138p. Its share price has fallen two thirds from its peak to languish at an 18-year low.

Warm front

Centrica investors do have one thing to keep them warm, a crackling yield of 8.7%. That is fiery income by anybody's standards and will theoretically double your money in less than 12 years, all things being equal (which admittedly they won't be).

Since you can buy the stock at a bargain valuation of just 8.2 times earnings, it would seem a no-brainer to lock-in now and keep reinvesting those dividends until the sun shines on Centrica again. Sadly, there is no such thing as a no-brainer when investing in stocks and shares. Centrica is tempting, but also troubled.

Brain storm

The first thing you have to apply your mind to is whether Centrica's dividend is safe. Last month's trading statement shed light on management's attitudes, stating that the current level of the dividend per share is underpinned by net debt remaining within the group's targeted range of £2.5bn to £3bn, and 2017 adjusted operating cash flow of more than £2bn.

Dividend cover from earnings is already thin at 1.4 and forecast to get even thinner at just 1.1 times, but management is willing to operate with cover below historic levels as it diversifies and seeks new sources of gross margin. That is sorely needed, with the current operating margin of 8.8% forecast to fall to a wafer thin 3.5%.

Tariff terror

The chill factor is high with Centrica warning that annual profit would miss market expectations due to poor performance in its business energy supply division. It also trades under the shadow of Prime Minister Theresa May's pledge to crack down on the Big Six, with a draft energy bill potentially forcing regulator Ofgem to cap standard variable tariffs for gas and electricity until 2023.

Group 2017 outlook was based on expectations of warmer than normal weather this winter but those now look awry as Arctic storms sweep the UK. Cold weather may be bad for your chilblains but it is good for Centrica's bottom line, as was this week's surge in gas prices following the explosion at a natural gas facility near Austria's border with Slovakia and the closure of Britain's Forties pipeline due to a crack. It is an ill wind that blows nobody any good.

Sunny side up

Centrica investors must be patient before they see those sunlit uplands. Three years of negative earnings per share growth look set to continue in 2017, with City analysts forecasting a drop of 25%. However, the outlook is brighter, with anticipated growth of 13% in 2018.

Analysts also reckon the yield will still be at a dizzying 8% at that point. It is rare for a yield to run this high for several years, although of course it is not baked-in. Here's another 8% yielder to consider. Centrica's cold snap may continue but far-sighted investors should look beyond that.

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Harvey Jones has no position in any of the shares 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.

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