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Stockwatch: A 7%-yielder upgraded

Are shares in insurer/lifestyle services group for the over-50's Saga (SAGA), finally turning? Last December, at 140p, and with the chief executive buying £99,500 worth at 138.2p, I rated Saga 'Avoid' as I did at 185p when the group floated in June 2014.

The narrative had achieved a rating based on prospects to maximise returns from a customer base of well-off older people, but the group remains substantially weighted to insurance, a highly competitive sector where stocks are priced to exacting high yields as compensation for the perceived risks.

For example, Aviva (AV.) yields 5.6% and Direct Line (DLG) 6.1% and, while Saga traded volatile-sideways from about 150p to 225p over 2015 to 2017, it was yielding roughly 3-4%.

So, when a 6 December update cited more challenging trading in insurance broking and the travel side, hurt temporarily by Monarch Airlines' administration, the stock lurched down to exact a higher yield commensurate with other insurers.

I suggested continuing to hold if you already had the shares, but that fresh money should wait and see how numbers evolve, and the new chairman. Over the first three months of 2018 the stock then extended its fall to 110p, but started rising at end-March and, in response to latest 2017 prelims, rose initially from 117p over 128p settling at about 123p.

On a chart view that represents a quite flat "bowl" or at least testing a break-out from the 2018 range, as if potentially forming a low. Thus, it's worth examining the results because, if a 9p total dividend can realistically continue, then the stock will enjoy further upside as it adjusts for risk.

At 123p the prospective yield is 7% covered about 1.5 times by earnings and a robust cash flow profile (see table).

SAGA - financial summary            
year ended 31 Jan           Estimates
  2014 2015 2016 2017 2018 2019
Turnover (£ million) 944 900 963 871    
IFRS3 pre-tax profit (£m) 171 114 176 193    
Normalised pre-tax profit (£m) 179 138 185 195 190 177
Operating margin (%) 17.6 17.6 20.5 24.1    
IFRS3 earnings/share (p) 11.4 8.5 13.2 14.1 13.0  
Normalised earnings/share (p) 12.1 10.8 13.9 13.7 13.8 13.2
Earnings per share growth (%) -0.6 -10.8 28.1 2.0 0.0  
Price/earnings multiple (x)         8.8 9.2
Historic annual average P/E (x) 14.2 17.8 14.9 14.0 8.8  
Cash flow/share (p) 15.7 15.4 13.5 12.4    
Capex/share (p)   2.6 3.0 3.9    
Dividend per share (p)     6.3 7.7 9.0 9.0
Dividend yield (%)         7.4 7.4
Covered by earnings (x)     2.2 1.8 1.5 1.5
Net tangible assets per share (p)   -47.0 -40.2 -30.7 -28.8  

Source: Company REFS                       Past performance is not a guide to future performance

How many shares might the new chairman buy?

Saga's de-rating also reflects concerns that a strategy of various commercial strands - linked to well-off older people - isn't matching hopes. Cynics would say it's an insurer trying to be a conglomerate with all the risks that entails, although the present CEO says there are no plans for further structural changes; that there's plenty to go for, attracting a new generation of retirees with a taste for adventure.

So, when Patrick O'Sullivan assumes the chair from 1 May, it seems unlikely he will conduct much of a strategic review. Indeed, his background is mainly financial services than 'lifestyle' marketing, as chairman of Old Mutual (OML), the FTSE 100 (UKX)-listed financial services group, also a Lloyd's market specialist motor insurer.

Now Saga is out of its closed period on share dealings, however, it will be interesting to see what extent of cash he puts into Saga equity, relative to his £325,000 pay. Market price was not influenced by his appointment nor the resignation of the chief financial officer at end-March to join Paddy Power Betfair (PPB) (remaining at Saga until September).

Fairly static results, 9p dividend prospects affirmed

Were it not for the dividend, the latest figures are uninspiring, if meeting guidance: a 1.4% rise in underlying profit before tax to £190 million with underlying earnings per share (EPS) 0.7% ahead at 13.8p, albeit near 8% declines in both at the headline level and "available operating cash flow" is down 19.3% to £175.5 million.

Profit is guided down about 5% for the current financial year due to investment in growing the customer base from its static level, which already shows "some initial momentum in new business."

The operations' narrative is mixed for example, with new ships arriving on the tour side in 2019 and 2020 gives a fair reading that the group is at least stabilising. Currently, the share price hinges on whether a 7.4% yield is appropriate compensation for holding risks, so, in the short term, it only needs perception to twig a bit more favourably in this regard, for the stock to rise.

The 9p per share dividend is covered about 1.5 times by normalised earnings and the financial review cites £1,249 million distributable reserves for distribution. The cash flow statement shows £98.8 million paid as dividends during the last financial year, which can come across as if future 9p payouts are fully underwritten, although the market will expect the board to decide prudently against profit and investment needs.

As things stand though, and a declared "commitment to a long-term sustainable dividend policy...the increase in the dividend reflects ongoing confidence in the stability of our highly cash generative model", the chart rise affirms 7%-plus as sufficient yield to tempt buyers.

Scope for the narrative to improve

In an effort to demonstrate better focus, last January there was a re-jig of the management structure: a new role of CEO of Saga Travel, restructuring the travel business to combine tours and cruises; the CEO of Saga Services was replaced, introducing an individual with a strong financial services background, also now responsible for Saga Money.

The group CEO says there is no need for further structural change, and revenues are shifting towards higher value, long-haul, river cruise products as the Travel side hits most of its sales target for the current year. He describes the decision to invest further in shipping capacity as "the highlight of the year...having two new efficient ships will significantly change Travel's profit trajectory." The market may await proof, but affluent pensioners' spending power will help.

Mind, this is taking attention off lacklustre progress in insurance where profits are down from motor and home, while private medical insurance is said performing "strongly" and travel insurance appears mixed.

The segmental performance shows underlying pre-tax profit comprising £130 million altogether for such retail broking activities, down 5.7%, insurance underwriting up 2.7% to £79.2 million, with travel soaring 36.9% to £20.4 million. The new ships certainly will need to be going full steam.

My concern, also as a 50-something targeted relentlessly by Saga insurance, is that, even when examining their various special offers, I have not been persuaded in the least to buy their car or home insurance. Not to over-state myself, but at the cutting edge of its marketing I'm not a buyer of Saga. As a financial analyst, however, I do sense investors are likely to warm to the yield, so perhaps this buys management time to improve.

"Averaging in" looks appropriate

Respecting the criterion for genuine growth prospects, you'd wait, although the narrative would have to worsen again for the stock to resume a downtrend. Net debt of £432 million is not onerous and its annual expense is covered about 10 times by operating profit.

Both on fundamentals and the chart, the stock is more likely stabilising, and a prospective yield better than other insurers makes it able to grind higher, with potential the cruise activities prove a winner. Possibly the chairman will make a respectable purchase, aiding sentiment further. Accumulate.

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