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Is Reed Elsevier the Ultimate Retirement Share?

Thursday - 12/13/2012, 5:15pm  ET

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 Reed Elsevier  , the specialist publisher and exhibition organizer.

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

Total Returns20082009201020112012*10-Year Trailing Average
Reed Elsevier -35.1% 5.2% 9.9% -0.3% 28% 2.9%
FTSE 100 -28.3% 27.3% 12.6% -2.2% 9.3% 9.1%

Source: Morningstar. *Year to Nov. 30, 2012.

(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.)

Reed Elsevier has performed strongly against the FTSE 100 this year, but its 10-year trailing average is disappointing and reflects the firm's slow recovery from the 2008 crash. However, the firm does now seem to be growing revenues and earnings once more, so could it be 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 Reed Elsevier shapes up:

ItemValue
Year founded 1894
Market cap (in billions of pounds) 7.7
Net debt (in billions of pounds) 3.3
Dividend yield 3.4%
5-Year Average financials
Operating margin 19.2%
Interest cover 5.0x
EPS growth 3%
Dividend growth 3.3%
Dividend cover 1.8x

Sources: Morningstar, Reuters, Reed Elsevier.

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

CriteriaCommentScore
Longevity Like many FTSE 100 firms, Reed Elsevier has a long pedigree. 5/5
Performance vs. FTSE Disappointing recovery from 2008 crash. 3/5
Financial strength High debt levels, but strong profitability. 3/5
EPS growth Earnings growth has been slow. 3/5
Dividend growth Average yield, slow growth and little capacity for big increases. 3/5
Total: 17/25

In common with many publishers, Reed Elsevier has struggled to generate growth from its stable of trade magazines and information services. Profits have risen, but these have mostly been the result of cost-cutting, which is probably approaching its limit. There doesn't seem any obvious catalyst for growth in Reed's publishing business, but it does remain profitable and the company's exhibition division reported a 34% increase in pre-tax profits for the first half of 2012, after launching a number of new events in overseas markets.

Looking at the bigger picture, Reed Elsevier has a fairly solid dividend history with only one cut -- in 2000 -- in the last 20 years. Although it took until 2006 for the dividend to regain its 1999 level, the company has continued to grow the dividend modestly each year, and the average five-year dividend growth rate of 3.3% has broadly kept pace with inflation. Reed's five-year average dividend cover level of 1.8 times suggests that the company does not have the capacity to grow dividends any faster, but its 3.4% yield is in line with the FTSE 100 average, so this is acceptable, if not outstanding.

Reed's operations are also highly profitable, despite their lack of growth. The group's five-year average operating margin is over 19%, and its operating profit for the first half of this year was 27%, which should enable the company to continue to pay down some of its substantial 3.3 billion pounds of debt. Reed's net debt equates to 2.3 times adjusted EBITDA, which is quite high and means that the firm's interest payments account for about 13% of operating profits -- reducing debt would therefore improve profitability, and free up cash for growth and dividend payments.

Overall, Reed Elsevier's score of 17/25 reflects its value as a solid, but unspectacular, retirement share. It has a long and successful history, and while many publishing companies are struggling to adapt to a low-cost digital future, this firm's bias toward trade customers and information services should help it mitigate this risk.

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