Is Meggitt The Ultimate Retirement Share?

Published in Company Comment on 25 October 2012

Will shares in Meggitt 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 Meggit (LSE: MGGT), an engineering company that provides components for the aerospace, defence and energy industries.

Robust returns?

Meggitt's engineering pedigree is impressive, but how has it performed against the FTSE 100 over the last 10 years?

Total Returns2007200820092010201110 yr trailing avg
Meggitt10.1%-50.3%68.0%45.6%-2.1%9.6%
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.)

The total return figures look impressive -- Meggitt has outperformed the FTSE 100 over the last ten years, despite having been hammered when markets crashed in 2008. That's a promising result, so let's take a closer look at the company's financials.

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 Meggitt shapes up:

ItemValue
Year founded1850
Market cap£3.0bn
Net debt£788m
Dividend Yield2.7%
5 year average financials
Operating margin17.7%
Interest cover12.4x
EPS growth (adjusted)15.2%
Dividend growth7.5%
Dividend cover3.0x

Source: Morningstar, Digital Look, Meggitt

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

CriteriaCommentScore
LongevityA long history of engineering in the UK and abroad.5/5
Performance vs. FTSEVery respectable.4/5
Financial strengthStrong margins and manageable debt.4/5
EPS growthEPS has grown steadily over the last five years.3/5
Dividend growthAttractive growth rate lends itself to long-term investment.4/5
Total: 20/25

Meggitt's score of 20/25 suggests that it could be an attractive candidate for a retirement fund portfolio. The lion's share of Meggitt's revenues come from civil aerospace (45%) and defence (40%), with most of the remainder coming from the energy industry (9%). Sitting alongside its FTSE 100 sector peers, Rolls-Royce Holdings (LSE: RR), BAE Systems (LSE: BA), Meggitt looks attractively priced with good growth prospects.

While Rolls-Royce, which has a similar mix of business, has outperformed Meggitt in recent years, it now looks expensive on a P/E of 17.6 and with a yield of just 2.0%. At the other extreme is BAE Systems, whose lowly share price means that new shareholders get a dividend yield of 6.0% and can buy a stake in Britain's largest defence company for just 6.8 times its 2011 earnings. The only problem is that BAE's future strategy is a little uncertain at the moment, following its failed mega-merger with Airbus parent EADS. Several big institutional shareholders are calling for boardroom changes at BAE, so further developments may be in the pipeline that could affect its earning power in years to come.

Meggitt sits attractively between Rolls-Royce and BAE, with a modest but confidence-inspiring P/E of 12.1, below the FTSE 100 average of 16. While Meggitt's 2.7% dividend yield is also below the 3.3% FTSE average, its affordable pricing and decent growth prospects means that over the long term, it should provide a steadily growing income -- the key to a good retirement share. By way of example, anyone who bought Meggitt shares for around 180p in 2003 will now be sitting on a healthy capital gain and will have received a dividend yield on cost of 6.1% for 2012.

Top income 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 owns shares in BAE Systems but does not own any of the other shares mentioned in this article.

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