On 10 September Saga (LSE:SAGA) reported its earnings. As a result the shares crashed about 10%. Are they now a bargain or a value trap?
What’s happened?
The insurance company reported an underlying profit before tax of £15.9m for its first half on Thursday, down 69.9% year on year. That sounds horrible but the results were in line with expectations.
My colleague Alan wrote a wonderful article about Saga’s results. Obviously, the company’s earnings declined significantly, while its debt level soared. So, the whole situation looks worrying. But I also agree with the management’s optimism about raising £150m in new equity. It surely improves the company’s cash position, which is experiencing big challenges right now. At the same time, I’d say it’s also a blow for the existing shareholders. Why? Well, as of the time of writing, the company’s market cap is £179.52m. It’s just slightly above the new equity issued. This means Saga shares will plunge in value straight after the new issue because of the dilution effect. Not good. But, unfortunately, the company has little or no choice.
Why is that? Well, that’s because Saga has been hit really hard by the Covid-19 crisis. The insurance (motors and homes) divisions held up relatively well at the time. But Saga also has a strong focus on the travel sector, which isn’t generating positive cash inflows right now. What’s more, management estimates that the cash ‘burn’ for the travel business will be about £6m to £8m per month in the second half of this year. But management also admits the business can only recommence cruises in April 2021. Looks like the cash ‘burn’ will continue in the first half of next year. Not very inspiring! But due to the equity raise, the company still has a cash pile to survive this time period and beyond.
Are Saga shares worth buying?
Saga’s credit rating is B1, junk. Moody’s considers the company to be well-diversified. What’s more, according to the agency, Saga enjoys consumer brand loyalty. But the debt level is high and will stay so due to the travel division. Although the company has always enjoyed high profit margins, they won’t be high again until the coronavirus crisis is over.
At the same time, I am sure ‘this too shall pass‘. The pandemic will end. But the question of timing is crucial here.
A £100m investment by Sir Roger De Haan makes me feel more optimistic. He is the former chair of the company, so the move is quite symbolic. As an insider he should know how likely or unlikely the company is to survive. If he bought such a large stake, then he must be certain the company will overcome the current crisis.
It’s important to realise that Saga is a small-cap company. What’s more, it is operating in a sector that has to go through a challenging period. But if you are a contrarian investor, you might like to follow Sir Roger and buy Saga shares. If the pandemic ends soon, you will get really good returns. But The Motley Fool offers lots of exclusive catalogues where you can find even better investment ideas.
