Can GKN's (LON: GKN) total return beat the wider market?
To me, capital growth and dividend income are equally important. Together, they provide the total return from any share investment and, as you might expect, my aim is to invest in companies that can beat the total return delivered by the wider market.
To put that aim into perspective, the FTSE 100 has provided investors with a total return of around 3% per annum since January 2008.
Quality and value
If my investments are to outperform, I need to back companies that score well on several quality indicators and buy at prices that offer decent value.
So this series aims to identify appealing FTSE 100 investment opportunities and today I'm looking at GKN (LSE: GKN), which is a global engineering company.
With the shares at 247p, GKN's market cap. is £4,029 million.
This table summarises the firm's recent financial record:
|Year to December||2007||2008||2009||2010||2011|
|Net cash from operations (£m)||240||259||227||33||454|
|Adjusted earnings per share||23.69p||23.7p||5.7p||20.7p||22.6p|
|Dividend per share||9.11p||4.5p||0p||5p||6p|
GKN is an engineering group employing around 44,000 people in more than 35 countries. The firm reckons its technologies and products are at the heart of vehicles and aircraft produced by the world’s leading manufacturers. Indeed, its products, like drive shafts and axle joints, are responsible for making most of the cars around the world move.
Around 46% of revenue came from the company's Driveline division last year, 24% from Aerospace, 14% from Powder Metallurgy, 14% from Land Systems and 2% from other sources. Europe is the most important region producing around 47% of revenue, followed by the Americas at 37% and 16% from the rest of the world.
It's clear from the table that GKN's markets are cyclical. In fact, the company required a dilutive six for five Rights Issue in 2009 that raised about £400 million to pay down some of its debt and support its balance sheet. The firm issued around 800 million new shares, roughly doubling the share count. It's often a good idea to hold cyclical, high beta shares on the up-leg of economic cycles. If the current recovery proves to be enduring, GKN could offer investors decent total-return potential from here.
GKN's total-return potential
Let's examine five indicators to help judge the quality of the company's total-return potential:
1. Dividend cover: free cash flow covered last year's dividend almost twice. 3/5
2. Borrowings: net gearing is about 37% with net debt around 1.7 times earnings. 4/5
3. Growth: growing revenue and earnings with recent good support from cash flow. 4/5
4. Price to earnings: a forward eight compares well with growth and yield forecasts. 4/5
5. Outlook: satisfactory recent trading and an ambivalent outlook. 3/5
Overall, I score GKN 18 out of 25, which encourages me to believe that, given a steadily improving macro-economic environment, the firm has potential to out-pace the wider market's total return, going forward.
Since raising more money on the stock market during 2009, GKN's debt seems to be under control. Cash flow has come back from its nadir in 2010 and there's reasonable free-cash dividend cover and plenty of cash to meet interest payments. One thing noticeable from the table of results is that the business has grown beyond a mere cyclical recovery; all of revenue, profits and cash flow now comfortably exceed the pre-crisis levels seen in 2007, although earnings-per-share figures are down due to the Rights-Issue dilution.
Yes, GKN is a growing business, although the latest company guidance sees the directors speak of softening demand in some areas. Despite the fivefold share price increase since the dark days of 2009, I'm happy to put GKN on my watch list and may even buy the shares if something knocks them back.
Generally, I'm more likely to buy shares when a company hits a spot of bother, as that's often when I find bargains. Investors tend to like bargains as share price recovery from low levels can lead to enhanced total returns. Right now, on one selection I find myself in the company of master investor Warren Buffett. In fact, the share in question is the only publicly listed UK company in which the American financial wizard holds shares. You can find out why in the Motley Fool's report "The One UK Share That Warren Buffett Loves." For a limited period, the report is free, so to download your copy and find out the identity of the one UK share that screams 'buy' to so many, click here.
> Kevin does not own shares in GKN.