Centrica (LSE: CNA) shares sunk 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 Centricas 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, Ill 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?
Centricas 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 Centricas divisions last year, leaving the firms 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 years dividend which cost around 860m look too generous.
Despite this, many investors will have been surprised in Centricas 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 dont 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 SSEs payout might be cut, most likely next year.
Although the firms finances are not as stretched as those of Centrica, SSEs cash flow is likely to will be tight this year, and earnings cover for the dividend will fall below the firms 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 Centricas 30% reduction could make sense, and would bring the firms 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 Mays general election. This could even be a good buying opportunity.
However, you might like to consider a second view before making a final decision — and may be interested know that only one of these three stocks was selected for the Motley Fool’s latest wealth report,“5 Shares To Retire On“.
The utility in question offers a 5% yield, and the Fool’s analysts believe it has some clear advantages over its peers.
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Roland Headowns shares in SSE. The Motley Fool UK has recommended Centrica. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.