I firmly believe the best stocks to form the foundation of a successful retirement portfolio are those which enjoy strong cash flow and have the potential to provide many years of rising dividends. Reinvest those dividends, and your income once you cease work could benefit greatly.
I see defence contractor QinetiQ (LSE: QQ) as falling into that category, and I see its unloved share price as providing a nice bargain at the moment — even after it’s enjoyed a bit of a recovery so far this year.
There was a modest uptick Wednesday as markets reacted well to a first-quarter trading update, which said: “Underlying trading for the group was as expected during the first quarter, with no change to expectations for group performance in the current financial year.”
That might not sound exciting, but with Brexit and trade wars making markets feel nervous, and a number of companies downgrading their guidance, an ‘all’s fine’ update really does seem like good news.
Earnings dip
Forecasts suggest EPS will dip by 12% this year, but I’m not too worried about that as the defence business really is focused on the seriously long term. And I also reckon P/E multiples of around 16 are fair value.
But the big thing for me is QinetiQ’s dividend prospects. My colleague Rupert Hargreaves thinks there’s significant upward potential for the annual cash payments, and I agree. The yield for 2018 came in at a modest 3.1%, and the share price recovery since then has dropped forecast yields to only around 2.5%.
But we’re looking at rises ahead of inflation, with payments very well covered by earnings. And unlike a lot of big dividend payers, QinetiQ has no debt – in fact, there was net cash of £267m on the books at 31 March.
Bigger yield
BBA Aviation (LSE: BBA) is another company I rate highly as a long-term dividend stock, and it’s actually offering a bigger dividend yield at the moment with forecast suggesting 3.2% this year and 3.4% next.
We haven’t seen the same progressive rises as from QinetiQ, and the payment was actually cut slightly in 2016 and held at the same level the following year. But that was in response to an EPS drop of 18% in 2015, the year in which it acquired competitor Landmark, which left that year’s dividend relatively weakly covered.
But after a strong earnings recovery, we’re looking at dividends set to resume their annual rises from this year, with predicted cover back up to around 1.8 times.
Growth ahead?
Fellow Fool write Royston Wild believes that BBA has some significant growth potential ahead of it, including possible future acquisitions, and I reckon that should cement the basis for further steady dividend rises in the coming years.
As a company in pursuit of acquisitions, BBA does carry net debt, which stood at $1,167m at 31 December 2017. But it was down from $1,335m a year previously. That represents a net debt-to-EBITDA ratio of approximately 2.6 times, and I wouldn’t like to see it get much higher than that. But strong free cash flow (of $220.7m in 2017) softens my concerns on that front.
BBA shares have put in a 59% rise over the past five years, but I still see a 2019 P/E valuations of 16.6 as not being too stretching.
