Is Centrica The Ultimate Retirement Share?

Published in Company Comment on 7 September 2012

Will shares in Centrica help you build a FTSE-beating retirement fund?

The last five years have been tough for those in retirement. Portfolio valuations have been hammered and annuity rates have plunged. There's no sign of things improving anytime soon, either, as the eurozone and the UK economy look set to muddle through at best for some years to come.

A great way of protecting yourself from the downturn, however, is by building your retirement fund with shares of large, well-run companies that should grow their earnings steadily over the coming decades. Over time, such investments ought to result in rising dividends and inflation-beating capital growth.

In this series, I'm tracking down the UK large-caps that have the potential to beat the FTSE 100 (UKX) over the long term and support a lower-risk income-generating retirement fund (you can see the companies I've covered so far on this page).

Earlier this week I looked at BG Group, the gas exploration and production company that was demerged from British Gas in 1997. Today, I'm going to take a look at the other half of the demerger -- Centrica (LSE: CNA), the company that operates the British Gas brand today, supplying gas to more than 15m residential customers across the UK.

Gas-fired growth

Centrica has comfortably outperformed the FTSE 100 over the last 10 years, delivering strong returns for investors:

Total Return20072008200920102011Trailing 10 yr avg.
Centrica4.4%-22.1%10.3%22.6%-8.3%9.4%
FTSE 1007.4%-28.3%27.3%12.6%-2.2%7.3%

Source: Morningstar

(Total return includes both changes to the share price and reinvested dividends. These two ingredients combined are what make it possible for equity portfolios to regularly outperform cash and bonds over the long term.)

Centrica's impressive trailing 10-year average total return reflects its attractive mixture of share price and dividend returns. Thanks to its regulated utility business, it is able to offer fairly generous and stable dividends, regardless of movements in gas prices.

What's the score?

To help me pinpoint suitable investments, I like to score companies on key financial metrics that highlight the characteristics I look for in a retirement share. Let's see how Centrica shapes up:

ItemValue
Year founded1997*
Market cap£17.4bn
Net debt£3.7bn
Dividend Yield4.6%
5 year average financials
Operating margin9.9%
Interest cover9.1x
EPS growth11.4% (adjusted)
Dividend growth9.6%
Dividend cover1.9x

Source: Morningstar, Digital Look

*Centrica was the result of the demerger of British Gas plc in 1997 -- the company's business, and most of its assets, are much older.

Here's how I've scored Centrica on each of these criteria:

CriteriaCommentScore
LongevityCentrica's history gives it maturity beyond its years.3/5
Performance vs. FTSEStrong, but not as good as its sibling, BG Group.4/5
Financial strengthPretty solid.4/5
EPS growthAdjusted EPS figures show steady growth.4/5
Dividend growthThis is definitely an income share and offers an attractive yield and historical dividend growth rate.4/5
Total: 19/25

A score of 19/25 is attractive and suggests that Centrica could be a strong candidate for a retirement fund portfolio. However, it's worth making sure that you understand the true nature of the company. Although it started out as a supply-side utility and is often referred to in that way, today's Centrica is an integrated energy company, making roughly half its profits from exploration and production (upstream) and half from retail sales of gas (downstream).

All of this means that Centrica is a more diversified business than it used to be, but also one that is more exposed to the general movements of the global energy markets than conventional utility companies.

Expert selections

Although doing your own research is important, another good way of identifying great dividend-paying shares is to study the choices of successful professional investors. One of the most successful income investors currently working in the City is fund manager Neil Woodford, who manages more money for private investors than any other City manager. Neil Woodford's dividend stock picks outperformed the wider index by a staggering 305% in the 15 years to 31 December 2011.

You can learn about Neil Woodford's top holdings and how he generates such fantastic profits in this free Motley Fool report. Many of Mr Woodford's choices look like excellent retirement shares to me and the report explains how he chose some of his biggest holdings.

This report is completely free and I strongly recommend you download"8 Shares Held By Britain's Super Investor" today, as it is available for a limited time only.

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Further investment opportunities:

> Roland does not own shares in any of the companies mentioned in this article.

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Comments

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belgraviadave 08 Sep 2012 , 11:05am

Why no management rating and why such a high financial strength rating? Net debt at 22% of market capital for a cash cow is absurd - they are borrowing to pay dividends. Suggests financial management is short-termist and therefore poor.

F958B 09 Sep 2012 , 9:42pm

belgraviadave

Although Centrica's debt increased, the company's net assets increased even more.
Assets increased by £2.1bn. Assets net of debt increased by 0.4bn.

Quite likely, the increased debt was to facilitate investment.

A considerable debate occurred on company debt, optimum levels of debt, negative cashflows and share buybacks here (admittedly Morrisons, but the general points raised in the discussion could apply to the debt of any company):
http://boards.fool.co.uk/morrison-interims-12634710.aspx?sort=whole

I'm happy to hold.

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