Is Tullow Oil The Ultimate Retirement Share?

Published in Company Comment on 26 September 2012

Will shares in Tullow Oil 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).

Today, I'm going to take a look at Tullow Oil (LSE: TLW), the FTSE 100's largest independent oil company. Shareholders who bought shares in the late 1980s and still hold them today have made capital gains in excess of 6,000% -- but how does it look as a retirement share?

Rocket-fuelled returns

First of all, let's take a look at how Tullow has performed against the FTSE 100 over the last 10 years:

Total Return20072008200920102011Trailing 10 yr avg.
Tullow Oil65.1%2.1%98.8%-2.9%11.8%30.1%
FTSE 1007.4%-28.3%27.3%12.6%-2.2%8.6%

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.)

Tullow's 10-year average trailing total return is massively impressive but reflects a period of very strong growth that might not be repeated. What's more important to us are its future prospects and long-term solidity.

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 Tullow Oil shapes up:

ItemValue
Year founded1985
Market cap£12.5bn
Net debt£1.8bn
Dividend Yield0.9%
5 year average financials
Operating margin36.5%
Interest cover6.0x
EPS growth65.7%
Dividend growth10.6%
Dividend cover3.9x

Source: Morningstar, Digital Look, Tullow Oil

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

CriteriaCommentScore
Longevity27 years is not much in FTSE 100 terms.3/5
Performance vs. FTSEThe last decade has been outstanding.5/5
Financial strengthHigh profit margins and ample interest cover.4/5
EPS growthImpressive growth record.4/5
Dividend growthLess than stellar -- only boosted by a big increase last year.2/5
Total: 18/25

Tullow's score of 18/25 reflects its stunning record of growth, which is partly the result of a superb exploration record -- few companies manage to hit oil more often than Tullow. However, while its status as a top tier exploration and production company is not in question, I am less sure about whether it has the potential to be a good retirement share.

Firstly, Tullow is a poor dividend payer, preferring out of necessity to retain the cash to use to fund new opportunities and development projects. This approach has been immensely successful and has generated great capital gains for long-term shareholders -- yet it isn't much use to anyone seeking a retirement income.

The other key question is what will happen next? Tullow currently boasts a P/E ratio of 31 -- a high rating that suggests the market expects it to continue growing at a very high rate. Yet this may not be possible -- at some point it will become so large that its growth will slow down. Ironically, the resulting down-rating of its share price could make it far more attractive as a retirement share, assuming its core business remained successful and profitable.

Eight expert stock picks

Doing your own research is important, but 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.

The good news is that 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 Tullow Oil.

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