Interactive Investor

Stockwatch: is there serious upside at this small-cap?

24th September 2021 11:12

Edmond Jackson from interactive investor

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Our columnist takes a close look at whether this stock could bag you a tidy return.

In early response to last Wednesday’s interim results from Saga (LSE:SAGA), the £475 million insurance and travel services group for the over-50s, the market appeared confused.

The stock opened up nearly 3% at 360p then dropped near and closed flat around 352p. It has remained edgy, however, falling back to 340p.  

I believe this reflects difficulty reading whether Saga is at a turning point for material upside once cruising fully returns and with “boutique” new liners.

Or, might the group languish with net profit short of pre-2019 levels (see table below). Insurance be constrained by competition and cruising by a permanent re-rating of costs, in terms of living with Covid.  

If the former scenario applies, then the stock is cheap given both profits and the stock’s price earnings (PE) will re-rate. But if the latter, then a single-figure forward PE is indeed more likely. 

Results statement began positively then became a curate’s egg 

It cites a 0.5% like-for-like increase in policies sold with 80.6% retention on existing policies, without mentioning profit.

Cruise bookings for next year are ahead of pre-pandemic levels and despite £5.9 million monthly cash burn on the travel side, that is below £7 million to £9 million guidance overall and cruise is cash flow positive. 

That suggests insurance is enabling the group to wash its face while an extent of Covid restrictions remain.

Helped by a new banking facility, Saga has £175 million liquidity. As Covid restrictions ease in due course towards normality for travel and capitalising on the new liners, record profits are in prospect. 

But reading down to “operating performance”, total retail broking earned fell 10% to £37.9 million, significantly offset by an 11% rise in underwriting revenue to £31.1 million. Total insurance therefore eased 1.4% to £69.0 million.

My concern here is that Saga should still be enjoying a boost from introducing three-year fixed-price cover policies, it claimed as a marketing coup for the over-50s.  

Rivals look anyway to be offering aspects of a fixed pricing approach and although some older folks may prefer to fix terms for three years, others are nimble with a computer mouse to find best value deals annually. 

My own impression of Saga policies is still being relatively expensive, although some would say the true test of an insurer is how well they handle a claim. 

Anyway, I have been concerned Saga’s key marketing pitch on insurance might lose novelty and here we are looking at a 10% drop in broking revenue earned. 

The insurance side has effectively been saved – to keep first-half profit near £70 million – by an £18 million reserves release on the underwriting side. But all insurers have been reporting strong results in this respect because they over-provided in their initial response to Covid. 

Losses on the travel side rose nearly 50% to £51.2 million where Saga may have incurred not only a hit to revenue but the cost of rolling forward bookings from periods when lockdown compromised travel.

While forward bookings mean a 70% load factor for cruise in 2021-22, it is yet to be seen how net profit will shape up if the cost of Covid procedures still weighs. 

“We have begun a phased resumption of our tour operations, however, Covid is still affecting them and we expect to take far fewer customers on holiday than we would normally in the second half of our financial year.”  

Much seems to depend on the extent the UK government can keep relaxing rules relating to travel; which assumes foreign countries get vaccinations sorted, otherwise a risk of importing Covid variants.  

“Other businesses” continued to make losses of just over £11 million and net finance costs rose 11% to £9.5 million. 

As a group, Saga made an overall £0.7 million pre-tax loss versus a £55.5 million loss although last year’s numbers included hits for goodwill impairment and restructuring on the travel side. 

£41.9 million operating cash flow was generated versus a like-for-like £23.2 million outflow – due to positive working capital movements on cruise, versus capital injections required previously. 

Saga - financial summary
Year end 31 Jan

  2015 2016 2017 2018 2019 2020 2021
Revenue (£ million) 901 963 871 860 842 797 338
Operating margin (%) 12.6 18.3 22.2 21.0 -16.0 -37.7 -18.1
Operating profit (£m) 114 176 194 181 -135 -301 -61.2
Net profit (£m) -134 141 157 139 -162 -313 -67.8
Reported EPS (p) 117 180 191 179 -198 -382 -67.0
Normalised EPS (p) 129 183 193 185 51.5 -56.3 -17.3
Operating cashflow/share (p) 212 183 169 164 181 112 -77.5
Capital expenditure/share (p) 36.0 41.2 53.4 100 76.9 360 282
Free cashflow/share (p) 176 142 115 64.1 104 -248 -359
Dividend/share (p) 56.0 98.4 116 123 54.6 17.8 0.0
Earnings cover (x) 2.1 1.8 1.7 1.5 -3.6 -21.5  
Cash (£m) 199 107 109 83.2 123 97.9  
Net debt (£m) 499 461 379 373 347 565 721
Net asset value (£m) 984 1,088 1,195 1,226 961 588 681
Net asset value/share (p) 1,210 1,330 1,460 1,495 1,170 716 486

Source: historic company REFS and company accounts

Overall tenor of statement is therefore neutral for sentiment 

Some investors will take encouragement, others can pick holes. Certainly, group financial risk has improved, helped by last September’s £150 million equity capital-raise, albeit at the cost of circa 68% dilution.

It needs bearing in mind when considering scope to recover net profit near £200 million like before 2019. Earnings per share (EPS) will not be commensurately similar.

Also mitigating risk, last July Saga issued a new five-year £250 million bond - to fund the £100 million settlement of an existing one and repay a £70 million term loan.

Cash thereby increased by £76 million. The maturity of a revolving credit facility was extended to May 2025, with a series of covenant changes. 

The balance sheet shows £904 million financial liabilities which include ship loans, relative to £203 million cash and £687 million net asset value.

Rather than assume management’s presentation of £227 million net debt, I prefer to include the value of ship loans which puts net gearing around 102%. The income statement shows this costing £22 million by way of finance costs, for six months. 

Management cites £175 million available cash resources additional to £100 million available from the revolving credit facility. However, if not stipulated by regulators, for practical reasons an insurance and travel group should anyway operate with a substantial cash buffer.  

Stock is up around 90% since last November: what action to take, if any? 

Ten months ago, I rated Saga a “buy” at 183p, significantly as a result of vaccines’ success. This would release pent-up demand for cruises among affluent older folk seeking more enjoyment in their silver years.  

Despite my scepticism about an enduring competitive advantage with three-year fixed-price home and car insurance, I do think Saga has a strong long-term offering for cruises.

Its relatively small new liners mean every cabin has a sea view; and bespoke treatment includes a “free” chauffeur service to start your holiday relaxed.  

Circa 350p is just over 23p in “old money” following a one-for-15 share consolidation.

Perhaps it is worth recalling, two US financial investors made approaches with offers up to 33p a share, which appeared to partly trigger the return of Roger de Haan (the now 72-year-old son of Saga’s founder) as a 20% shareholder. A culture of US opportunism for UK takeovers has not gone away. 

Chief risks are competitive pressures in insurance conflating with a challenging few years ahead to manage the travel industry profitably.

At least cruise holidays are relatively controlled versus restrictions liable to suddenly hit travel abroad: liners can simply avoid stopping in ports, for guests to wander around.  

The population segment Saga targets is affluent and unlikely to be hurt by higher energy bills or inflation generally; they want to enjoy the years they have left. 

While the stock could easily consolidate around this level, I think overall it justifies retaining. Extent of upside is a speculative view, according to “the new normal” of coping with Covid, and competition within insurance. Hold.  

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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