After several years of underperformance, Saga (LSE:SAGA) shares appear to be in recovery mode. Year to date, its share price is up about 75% – well ahead of the UK stock market as a whole. Over a year, the stock’s up a little over 80%.
Should I buy Saga shares as a recovery play? Let’s take a look at the investment case.
Is Saga turning things around?
Recent news from Saga has generally been quite encouraging. On 14 June for example, the company advised its travel business is due to restart from 27 June (subject to government restrictions) This is a big plus, even if it’s only initially for UK itineraries. In the year before Covid-19, the travel division was responsible for almost 20% of the company’s underlying profit before tax. So, activity in this division should boost the company’s profits.
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Saga also said on 14 June its liquidity remains strong. The company said it had total available cash of £78m on 31 May and that its net debt-to-EBITDA ratio was 2.9 as of that date (excluding Cruise), well within the current covenant in short-term bank debt of 4.75.
Yesterday, Saga also announced it plans to issue a fixed-rate bond of £250m. This will improve its financial flexibility and increase available liquidity. We don’t know the terms of this bond. However, the market appeared to like this development with Saga’s share price shooting up 6% after this news.
It’s worth pointing out that management appears to be confident about the future. “Looking ahead, while we are mindful of continued uncertainties around Covid-19 and the outlook for the consumer economy, we are confident we have the right strategy and people in place to return Saga to sustainable growth,” said CEO Euan Sutherland in mid-June. Sutherland recently spent around £200k on Saga shares, which suggests he’s genuinely confident in the turnaround story.
Risks
I do have some concerns about Saga shares however. One is in relation to the group’s insurance division, which generates the majority of profits. In mid-June, the company said conditions in this area are “challenging” with continued premium deflation across the market. For the four months to 31 May, motor and home policy sales were 2% behind the same point last year, which is disappointing.
Another issue for me is that, historically, Saga hasn’t been very profitable. Between 2016 and 2020 (the five years pre-Covid-19), the company generated an average return on capital employed (ROCE) of just 0.04%. That’s very poor. Over the long run, a company’s share price performance tends to match its ROCE. Saga’s indicates that the stock may not be a good long-term investment.
Finally, there’s the valuation. Currently, Saga has a forward-looking P/E ratio of 24.3. That’s quite high, in my view. That said, if we use the earnings estimate for next financial year (ending 31 January 2023), the P/E falls to 7.4, which is quite low.
Saga shares: should I buy?
I think Saga’s share price could continue to rise in the short term. However, given that the business hasn’t historically been very profitable, I’m not going to buy the shares. I think there are better options today for a long-term investor like myself.
