Is BAE Systems the Ultimate Retirement Share?

LONDON -- The last five years have been tough for those in retirement. Portfolio valuations have been hammered, annuity rates have plunged, and uncertainty has ruled the roost. There's no sign things will improve any time 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 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, especially if you keep the shares within a tax-efficient ISA or SIPP.

It's no coincidence that the world's most successful investor, Warren Buffett, prefers such companies. He recently invested in a large FTSE 100 company that fits the bill perfectly. You can find full details in this free report.

In this series, I'm tracking down the U.K. large caps that have the potential to beat the FTSE over the long term and support a lower-risk, income-generating retirement fund. Today I'm going to take a look at BAE Systems (LSE: BA.L  ) , the U.K.'s largest defense company.

Indecent exposure 
BAE's share price has been in the doldrums for the last few years, but the company has remained profitable and pays handsome dividends to its shareholders. Most of BAE's sales come from the U.K. and the U.S., while India, Australia, and Saudi Arabia are also important markets. Unfortunately, BAE's focus on the U.S. and U.K. has meant that it has been exposed to recent defense spending cuts. The company's revenue fell by around 15% last year, although profits held firm, and things are expected to pick up this year.

If you are building up a retirement portfolio, total return is a useful metric for measuring the performance of your stock, as it captures the effects of share price changes 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. Sadly, BAE has not managed to outperform the FTSE 100 over the last 10 years, as these figures show:

 

2007

2008

2009

2010

2011

Trailing 10-year Average

BAE Systems Total Return

19.8%

(21.6%)

(0.6%)

(3.6%)

(8.2%)

2.9%

FTSE 100 Total Return

7.4%

(28.3%)

27.3%

12.6%

(2.2%)

5.9%

These figures suggest that BAE felt the full impact of the recession later than the majority of other FTSE 100 companies, but that it is recovering more slowly, too. This makes sense when you consider that most of its income comes from large, public-sector contracts, which are agreed well in advance of delivery. Cuts to future contracts take a few years to filter through to BAE's accounts, as can be seen from its below-par performance over the last two years.

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 BAE shapes up:

The basics

Year Founded 1977*
Market Cap 9.8 billion pounds
Net Debt 1.4 billion pounds

*BAE Systems was formed as British Aerospace through the merger of four existing aviation companies.

Five-year financials

Operating Margin

9.5%

Interest Cover

8.5

EPS Growth

31%

Dividend Growth

10.9%

Dividend Cover

2.61

Dividend Yield

4.56%

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

Criterion

Comment

Score (out of 5)

Longevity

BAE's corporate history only stretches back to 1977, but its component parts are much older, and its future as an independent British company seems fairly certain.

4

Performance vs. FTSE

It's lagged the FTSE in recent years but has remained profitable. As long as this continues, the share price will eventually catch up -- and the current 6% dividend yield is ample compensation in the meantime.

3

Financial Strength

BAE's debt levels rose fivefold last year, thanks in part to a 500 million pound share buyback. Despite this, net gearing is only 25%, and interest cover is generous. BAE also has 2 billion pounds in cash.

4

EPS Growth

EPS growth has been volatile over the last five years, but the trend is upward.

3

Dividend Growth

BAE has increased its dividend every year since 1999 -- a total increase of 135%. At the same time, dividend cover has remained strong.

5

 

 

Total: 19/25


Dividend excellence has helped BAE Systems to a score of 19/25 -- a very respectable score suggesting that BAE could be a strong candidate for a retirement fund portfolio. Indeed, it's a share I hold myself.

If you are interested in finding more high-yielding shares, I would strongly suggest you take a look at some of Neil Woodford's choices. Neil is one of the U.K.'s most successful fund managers, and he specializes in identifying companies with strong income potential. You can find out about eight of Neil's biggest holdings in this free Fool report, "8 Shares Held By Britain's Super Investor," which I strongly recommend.

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

Further investment opportunities:

Roland owns shares in BAE Systems. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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