LONDON — 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 things will improve anytime soon, either, as the eurozone and the U.K. economy look set to muddle through at best for some years to come.
A great way to protect yourself from the downturn, however, is to build 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 U.K. large caps that have the potential to beat the FTSE 100 over the long term and support a lower-risk, income-generating retirement fund (you can see all of the companies I’ve covered so far on this page).
Over the last few weeks, I’ve looked at 15 shares, and in this article I’m going to examine the five lowest-scoring shares — Carnival Corporation (LSE:CCL) , Severn Trent Plc (LON:SVT) , Capita , Banco Santander , and Reed Elsevier plc (LON:REL).
First, let’s take a look at how each of them scored against my five key retirement share criteria:
|Criterion||Carnival||Severn Trent||Capita||Santander||Reed Elsevier|
|Performance vs. FTSE||3||3||4||2||3|
|Total (out of 25)||13||16||16||16||17|
Carnival keeps on cruising
Almost exactly one year after Carnival hit the headlines when its cruise ship Costa Concordia was shipwrecked off the coast of Italy, the company is in the news again — this time after its Carnival Triumph cruise ship lost power in an engine room fire, forcing its 3,000 passengers to endure a week-long stay on the ship without power and, in many cases, without toilet facilities.
The news sent the company’s share price down by 5%, but the shares remain 27% higher than a year ago — a reminder that Carnival’s vast business encompasses many brands, such as P&O Cruises, Princess Cruises, and Cunard, which most passengers will not associate with Carnival at all.
From an income viewpoint, Carnival’s dividend remains lower than in 2007, it was canceled altogether in 2009, and it has only been covered by free cash flow once in the last six years. The company’s shares also look expensive to me, trading on a 2012 historical P/E of 19.9. It’s not a company I’d add to my retirement portfolio, especially given its net debt of 8.4 billion pounds.
Water utility Severn Trent didn’t score very highly in my review, earning a middling 16 out of 25 despite having an attractive and consistent dividend history. There were three main reasons for the firm’s poor showing: Earnings-per-share growth has been weak over the last five years, its dividends were not covered by free cash flow or earnings last year, and it has high debt levels, even by utility standards. All of this suggests to me that at some point it will have to tighten the purse strings, at which time its attractive 5% forward dividend yield could come under threat.
Furthermore, Severn Trent’s shares currently look quite expensive, trading on a 2012 historical P/E of around 20 despite the fact that U.K. water utilities are about to enter a new period of regulatory price controls, the details of which are not yet clear.
Business process outsourcing specialist Capita generates a lot of its revenue from the public sector — it runs operations such as carrying out disability assessments for the new Personal Independent Payment and running recruiting programs for the Army. In my original review, I mentioned that Capita was something of a serial acquirer, having acquired 14 companies in 2012 and 21 in 2011.
Since I wrote that, Capita has acquired another company: Northgate Managed Services, which provides managed IT services to public and private-sector organizations. This could be quite a smart acquisition for Capita, but it will no doubt have added to the company’s 1.5 billion pound net debt pile.
Capita’s shares are trading at all-time highs at the moment, but that’s no reason to buy the stock; I suspect there will be better opportunities to buy into this excellent business in the future.
Santander‘s 10% Yield
Spanish bank Santander combines a sizable domestic operation with a large and profitable emerging-markets operation. Santander’s key strengths lie in its Latin American operations, of which Brazil is the largest. The bank recently published its full-year results for 2012, showing that it had been forced to make a further 17 billion euros of provisions against bad debts relating to Spain’s battered property market. This pushed earnings per share down to 0.23 euros, but the bank did maintain its 0.60 euro per-share dividend payout, which equates to a 10% dividend yield.
An income like this is certainly a powerful attraction for retirement investors, but while Santander has remained profitable throughout the financial crisis, 50 billion pound banks do not normally provide a 10% dividend yield, so something must be amiss. In this case, the main risk shareholders must accept is that Spain’s recovery will not go to plan — further unexpected property losses and even a partial default on Spanish government bonds remain possible and would hit Santander hard.
The top scorer of the bottom five, specialist publisher Reed Elsevier has avoided the dramatic declines suffered by many publishers thanks to its focus on trade publications and digital services that remain in demand. Reed also has a profitable and growing exhibitions business, which complements its trade services. Despite these benefits, the firm has net debts of 3.3 billion pounds, the interest payments on which accounted for 13% of its operating profits last year and may be constraining dividend growth.
Earnings growth has also been limited, coming mainly from cost-cutting measures. Reed’s forecast dividend yield is 3.1%, slightly below the 3.3% forecast for the FTSE 100, and I think there are better retirement share options available elsewhere — although Reed has proved itself able to survive where some of its peers have struggled.
2013‘s top income stock?
The utility sector is known for its reliable, above-average dividends, but The Motley Fool’s team of analysts has identified one FTSE 100 utility share that they believe offers a particularly high-quality income opportunity. The company in question offers a 5.7% dividend yield, and the Fool’s analysts believe it could be worth up to 850 pence per share — offering new investors a potential 20% gain on the current share price of about 700 pence.
The article Are These the 5 Worst Retirement Shares in the FTSE? originally appeared on Fool.com.
Roland does not own shares in any of the companies mentioned in this article.
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