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Is Severn Trent the Ultimate Retirement Share?

http://www.fool.com/investing/general/2013/02/01/is-severn-trent-the-ultimate-retirement-share.aspx

Roland Head
February 1, 2013

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 Severn Trent (LSE: SVT), one of the U.K.'s largest water companies. Utilities -- with their reliable dividends -- are a traditional favorite of retirement investors, so how does Severn Trent shape up?

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

Total Returns

2008

2009

2010

2011

2012

10 yr trailing avg

Severn Trent

(17.1%)

(7.1%)

42.7%

5.8%

14.3%

9.3%

FTSE 100

(28.3%)

27.3%

12.6%

(2.2%)

10.0%

9.8%

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.

Severn Trent's 10-year average trailing total return shows that its performance has been very close to that of the FTSE 100. However, total return is made up of both share price return and dividend payments, whereas many utility investors, like me, are only interested in the income potential of these regulated businesses.

Severn Trent's share price has only gone up by 58% over the last 10 years, compared to 77% for the FTSE 100. Given that Severn Trent and the FTSE 100 have posted very similar total returns, this weaker share price performance suggests that Severn Trent's historical dividend yield is considerably higher than that of the FTSE 100 -- good news for income-hungry investors.

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 Severn Trent shapes up:

Item

Value

Year founded

1974

Market cap

£3.9bn

Net debt

£4.1bn

Dividend Yield

4.5%

5 year average financials

Operating margin

27.8%

Interest cover

2.2x

EPS growth

(7.3%)

Dividend growth

2.7%

Dividend cover

1.3x

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

Criteria

Comment

Score

Longevity

It's relatively young by FTSE 100 standards.

3/5

Performance vs. FTSE

It's almost level with the index, but offers a higher yield.

3/5

Financial Strength

Heavily geared, even by utility standards, but profitable.

3/5

EPS Growth

After falling for several years, earnings seem to be on the rise again.

3/5

Dividend Growth

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