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Is Fresnillo the Ultimate Retirement Share?

http://www.fool.com/investing/international/2012/09/20/is-fresnillo-the-ultimate-retirement-share-.aspx

Roland Head
September 20, 2012

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 (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 Mexican miner Fresnillo (LSE: FRES.L  ) , which is the world's largest silver producer and is also a significant gold producer.

A flying flotation
Fresnillo only floated on the London Stock Exchange in May 2008, but it has performed strongly against the FTSE 100 during that time, helped, of course, by strong gold and silver prices:

Total Return

2007

2008

2009

2010

2011

Trailing 3-Year Average

Fresnillo

N/A

N/A

248.0%

112.8%

-6.4%

35.7%

FTSE 100

7.4%

-28.3%

27.3%

12.6%

-2.2%

8.2%

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.

Fresnillo's total returns over the last three years have far exceeded those of the FTSE 100 -- but does it have what it takes to succeed as a retirement share, which requires solid performance over the long term?

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 Fresnillo shapes up:

Item

Value

Year founded 2008*
Market cap 13.4 billion pounds
Net cash 440 million pounds
Dividend yield 3.4%
5-Year Average Financials
Operating margin 53.5%
Interest cover N/A
EPS growth 51.6%
Dividend growth 108% (3-year average)
Dividend cover 3.2x

Source: Morningstar, Digital Look, Fresnillo. *Although Fresnillo was only floated on the LSE in 2008, it has been operating as a division of the Mexican Penoles industrial group since 1961 and was an independent company before that.

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

Criteria

Comment

Score

Longevity A newcomer, albeit with some very old mines.

2/5

Performance vs. FTSE An inspiring start, but this is a long race.

3/5

Financial strength Net cash and high profits mean it could withstand falling prices.

4/5

EPS growth Impressive so far, but slowing as costs rise.

3/5

Dividend growth Massive growth has kept pace with its share price.

4/5

Total: 16/25

A score of 16/25 reflects Fresnillo's combination of outstanding performance over a very short period. Its costs of production are lower than some of its peers, and it has benefited hugely from high silver and gold prices in recent years. At the same time, the company is investing considerable sums in its exploration activities in an effort to expand its asset base. It also faces rising costs -- it reported a 37% increase in production costs in its last half-year report. These two factors are likely to combine to reduce net cash inflow over the next few years.

I suspect that Fresnillo has a strong long-term future but like all cyclical shares, anyone planning to hold for the long term should buy it when it's at a low point in its cycle, not near the top, as it is now. Of course, if gold and silver continue to rise, Fresnillo shares might follow for a time -- but with a current P/E ratio of 27.6 and rising costs, this is not a risk I would take for a share in my retirement portfolio.

In contrast, a good exam