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 Melrose Industries (MRO 0.54%) (MLSP.F -1.15%), an unusual company which specialises in turning around manufacturing businesses, before selling them on. Melrose's current portfolio of businesses contains German utility meter maker Elster, Brush Turbo Generators and Marelli Motori, which make electric motors and generators, and Bridon, which makes rope and wire products used in the oil and gas industry.
Melrose Industries vs. FTSE 100
Let's start with a look at how Melrose has performed against the FTSE 100 over the last 10 years:
| Total Returns | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 YTD | 5 yr trailing avg |
|---|---|---|---|---|---|---|---|
| Melrose Industries | -40.7% | 115.7% | 77.7% | -10.7% | -31% | 18.8% | 10.2% |
| FTSE 100 | -28.3% | 27.3% | 12.6% | -2.2% | 10% | 9.9% | 5.3% |
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.)
In 10 years, Melrose has grown from a 13 million-pound AIM company to a 3.3 billion-pound FTSE 100 member. It moved onto the main market in 2005, and its five-year average trailing total return of 10.2% is almost twice the FTSE 100's 5.3% figure. Clearly, the company's management has been skilled at creating shareholder value, but will Melrose have the longevity required for a 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 Melrose shapes up:
| Item | Value |
|---|---|
| Year founded | 2003 |
| Market cap | 3.3 billion pounds |
| Net debt | 997.7 million pounds |
| Dividend Yield | 3.1% |
| 5-Year Average Financials | |
| Operating margin | 9.1% |
| Interest cover | 4.9x |
| EPS growth | -6.8% |
| Dividend growth | 9.2% |
| Dividend cover | 1.7x |
Here's how I've scored Melrose on each of these criteria:
| Criteria | Comment | Score |
|---|---|---|
| Longevity | It's still early days. Will it work over the long term? | 2/5 |
| Performance vs. FTSE | Very strong, but its track record is short. | 4/5 |
| Financial strength | No obvious problems. | 4/5 |
| EPS growth | Earnings tend to fluctuate due to the nature of the business. | 3/5 |
| Dividend growth | 57% dividend growth since 2008. | 4/5 |
| Total: 17/25 | ||
Melrose is essentially a publicly traded investment company, which plays an active role in turning around its acquisitions before targeting a sale within a typical timeframe of three to five years. The firm's specialist expertise is in the area of manufacturing, and the majority of the firm's senior management team previously worked at Wassall, a similar industrial investment company, in the 1990s. Wassall was successful and was acquired in 2000 in order that its new owner could merge with one of Wassall's portfolio businesses.
My concern is that Melrose, while successful, is not a conventional business, and is unlikely to provide a reliable, progressive dividend income to retirement investors. Its policy is to return the proceeds of its investments to shareholders where possible, which results in periodic special dividends and buybacks. However, this may also mean that periodic fundraisings are required to fund new acquisitions, as was the case in 2012, when Melrose raised 1.2 billion pounds in a rights issue.
My verdictI wouldn't add Melrose to my retirement portfolio for the reasons I've outlined above -- but I do think it's an attractive business with the potential to provide decent returns as part of an actively managed portfolio.
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