Is Associated British Foods The Ultimate Retirement Share?

Published in Company Comment on 1 November 2012

Will shares in Associated British Foods 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 Associated British Foods (LSE: ABF), the food group with a lucrative sideline in clothing retail, via its ownership of Primark.

Sweet performance

ABF's mixture of food and textiles has performed strongly against the FTSE 100 over the last ten years, as these figures show:

Total Returns2007200820092010201110-yr trailing avg
ABF11.3%-16.6%15.5%46.6%-4.2%10.5%
FTSE 1007.4%-28.3%27.3%12.6%-2.2%7.5%

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.)

ABF's 10-year trailing average return has left long-term shareholders substantially ahead of the FTSE 100 and it's worth noting the company has hammered the index so far this year, with a total return of 25.9% against the 7.3% provided by the FTSE 100.

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 ABF shapes up:

ItemValue
Year founded1935
Market cap£11.0bn
Net debt£1.3bn
Dividend Yield1.8%
5-year average financials
Operating margin7.5%
Interest cover9.2x
EPS growth7.8%
Dividend growth5.8%
Dividend cover2.8x

Source: Morningstar, Digital Look, Associated British Foods

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

CriteriaCommentScore
LongevityApproaching its first century.4/5
Performance vs. FTSEStrong outperformance.4/5
Financial strengthLow gearing and stable margins.4/5
EPS growthA big leap in 2010 helped raise the average.4/5
Dividend growthStrong and consistent.4/5
Total: 20/25

In addition to ever-popular clothes retailer Primark, ABF has a big food business that includes consumer brands -- such as Twinings, Silver Spoon and Ovaltine -- as well as a large wholesale ingredients business, built around its sugar empire.

It's a diverse mixture that seems to work well and has made the stock extremely popular with City investors, who have propelled the company's share price up 25% so far this year. Analysts are forecasting a 25% increase in pre-tax profits when ABF releases its full-year results on 6 November, so if these expectations are fulfilled, a further boost is likely to the share price.

The problem with all of this success is that ABF's price-earnings ratio is currently a heady 18.7, with a forecast P/E based on this year's expected earnings of 16.1. While not outrageously expensive, it isn't cheap either and ABF's cautious dividend payout approach means the shares yield a meagre 1.8%.

On the other hand, ABF has increased its dividend continuously since at least 1993 (the oldest figures I could find) and this reliable dividend growth means over time, income from ABF shares is likely to continue to grow and keep pace with inflation -- a desirable attribute for a retirement share.

ABF's score of 20/25 is well deserved, and while I don't think I would buy ABF shares at their current price, any temporary weakness would definitely make an excellent buying opportunity for a long-term investment.

Expert selections

Doing your own research is important, but another good way of identifying great retirement 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.

Warren Buffett buys British! The legendary investor has recently topped up on his favourite UK blue chip. Discover what he bought -- and the price he paid -- within our latest free report!

Further investment opportunities:

> Roland does not own shares in Associated British Foods.

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