Is IMI the Ultimate Retirement Share?

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 of things improving 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 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 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 the companies I've covered so far on this page).

Today, I'm going to take a look at engineering group IMI  (LSE: IMI  ) , one of the smaller companies in the FTSE 100.

IMI vs. FTSE 100
Let's start with a look at how IMI has performed against the FTSE 100 over the last 10 years:

Total Returns 2008 2009 2010 2011 2012 10-Yr. Trailing Avg.
IMI -25.7% 98.4% 86.5% -16.6% 48.4% 20.2%
FTSE 100 -28.3% 27.3% 12.6% -2.2% 10% 10%

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.)

IMI's meteoric growth over the last decade earned it promotion into the FTSE 100 in 2010 and means that shareholders have enjoyed an average annual return of twice the FTSE 100 average over the last 10 years -- not bad for a company that specializes in "the precise control and movement of fluids"! So does IMI have the makings of a great retirement share?

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 IMI shapes up:

Item Value
Year founded 1862*
Market cap 4.3 billion pounds
Net debt 117 million pounds
Dividend Yield 2.4%
5-Year Average Financials
Operating margin 13.5%
Interest cover 14.0x
EPS growth 15.6%
Dividend growth 10%
Dividend cover 2.1x

*The company that became IMI was founded in 1862, but from 1927-1966, it was part of ICI, which it helped found.

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

Criteria Comment Score
Longevity A long and respectable heritage. 5/5
Performance vs. FTSE Outstanding. 5/5
Financial strength Low debt, strong cash generation, but a big pension deficit. 3/5
EPS growth Strong earnings growth is expected to continue. 4/5
Dividend growth Decent growth with no cuts in more than 20 years. 4/5
Total: 21/25

Unlike many British engineering businesses, IMI has survived and prospered for more than 150 years. Although the nature of its business has changed several times over the years -- until the 1990s, its main area of expertise was metals -- this isn't unusual for successful engineering businesses, which tend to be driven by a combination of scientific discovery and economic necessity.

Although analysts' forecasts suggest IMI's earnings growth will accelerate over the next couple of years, it's fair to assume that it cannot maintain this level of growth indefinitely, and will eventually reach some kind of plateau. Yet under its umbrella description of fluid control, IMI's business is surprisingly diverse, covering the oil and gas sector, renewable energy, automotive engineering, heating ventilation and air-conditioning ("indoor climate") and retail dispensing. This diversity should help IMI adapt to future changes, if it's successfully managed.

In financial terms, IMI looks very healthy, with one possible exception -- a 232 million-pound pension deficit that has absorbed almost 70 million pounds of cash flow in additional funding over the last two years. Pension deficits are fairly common in U.K. companies that used to have large workforces with final salary pensions -- but if IMI's profits dip, the pension deficit could put the company's dividend growth under pressure.

My verdict
IMI's score of 21/25 is impressive, and I think that it could prove to be a very successful retirement share for longer-term investors. My main reservation is that the company's stock appears fully priced at the moment, with a price to earnings ratio of 18.8 and a dividend yield of just 2.4%. This, combined with its pension deficit, would probably stop me investing at the current price.

If I did decide to invest in IMI at the moment, then my preferred route would be to drip-feed money into the company's shares over a period of time, so that I could take advantage of the benefits of pound-cost averaging.

2013's top growth stock?
Discovering shares like IMI that can outperform the wider market over long periods isn't easy, but the Motley Fool's analysts have found one stock that they believe is worth far more than its current valuation.

The company in question outperformed the wider market by 32% in 2012 and has continued to move ahead of the FTSE 100 in 2013. It operates a number of businesses that are household names and has been very successful at profiting from an important new technology, unlike some of its peers.

All the details are available in this new free report, "The Motley Fool's Top Growth Stock For 2013," and if you would like to know more, I would strongly recommend you click here to download this report immediately -- it's completely free, but it will only be available for a limited time.


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