value and opportunity

The company:

Saga Plc is a UK company that combines two business that I have looked at quite often: Insurance and Travel.

Saga has its origin as a Seaside Hotel in England and then became a travel company before then moving into insurance in the 1980s. Saga caters specifically for the “over 50” market and claims to be the “leading provider” to people over 50 in the uK.

After a PE financed management buyout in 2007, he company was IPOed in May 2014 at a price of 185 pence / share.

Looking at the stock chart, IPO investors at first saw a decent outperformance before things went south this year:

So what happened this year ?

The big drop happened after a trading update in beginning of December 2017. They lowered their expectation for the current financial years but more importantly, they also lowered the profit target for 2018/19 with a fall by ~-5% againt an expected increase of +7%.

This lead to a drop from around 185 pence to a low of around 110p before the stock price recovered to around 130 pence at the time of writing.

In April they reported earnings which showed an actual drop in overall revenues but the stock price seems to have increased as the company increased its dividend which, according to the CEO shows their confidence for the future.

AFter the drop, the stock looks cheap Here a few key numbers:

Market Cap: 1.504 mn GBP
P/E: 10,3
Div. Yield: 6,7%
Operating margin: 22,3%

What I like about Saga

In principle, targeting travel and insurance offering to over 50-year-old sounds like a smart idea. Older people have different needs and for instance in the insurance space they are less likely to spend a lot of time comparing prices all the time especially if they are wealthy. The Saga brand as such seems to be quite popular in the UK and well-regarded and as such one should assume that clients are loyal to the brand and not overly price sensitive as long as prices are reasonable. Plus, the age cohort of 50+ people is constantly growing, so in theory this could be a long-term tailwind.

Saga’s Insurance business consists both, of an underwriting entity and a brokerage division. In insurance, brokerage is clearly the more attractive one as it is capital light. Saga seems to shift from broking only its own product into a third-party insurer brokerage model which in the long run could improve both margins and returns on capital. Sagas Profit are to a large extent brokerage profits (60-70%) which normally would justify significantly higher valuation multiples.

Some problems:

First of all, not all Saga Insurance clients seem to be loyal “affinity group” members. This is what Saga was “Hiding” in their preliminary result statements:

The UK home insurance market has remained competitive throughout the year. We have continued to experience the same flat premium environment as the wider market. In response, we chose to maintain the quality of our home business. Where we believe prices in the market are unprofitable we are prepared to lose business and this has resulted in a reduction in the number of core policies sold. Core policies reduced to 1,186k (2017: 1,254k

So they have been losing customers in 2017 whereas for instance Admiral has grown its home insurance clients by ~40% in the same period.

The question is if only a small number of Saga clients became less loyal or if this is a trend. I think there is the risk that “New” 50 year olds might behave very differently from let’s say 80 year olds which might not have used any electronic device in their whole life. This is something to be seen but for instance the rapid decline of printed copies of the “Saga Magazine” seems to indicate that there is clearly a shift in behaviour:

Circulation of Saga magazine has flagged in recent years from 632,217 in 2012 (when the cover price was £2.50) to 288,947 (at the current price of £4 per issue) All the staff are based at Saga’s HQ in Folkestone.

If there are any UK readers reading this, I would be highly interested in how the Saga brand is actually percieved in the UK. Any comments highly welcome !!!!

What I don’t like about Saga

Saga has a relatively weak credit profile (Non-investment grade rating of BB+). The reason for this is that they actually buy and hold cruise ships “On balance sheet”. They have announced to buy two new ships.

This is what they write about the existing ships:

Saga Cruising is an integral component of our brand and delivers the most differentiated customer experience of all our products. Underlying Profit before Tax4 for our two cruise ships, Saga Sapphire and Saga Pearl II, increased by £3.2m
to £6.6m (2017: £3.4m).

So this translates into less than 5% of the Group’s profits. Nevertheless this seems to justify the purchase of 2 new and very expensive Cruise ships:

On the 20 September 2017, the Saga plc Board approved the purchase of the second cruise ship, Spirit of Adventure, with an earlier delivery date of August 2020, and the Group exercised the option in December 2017. The financing for Spirit of Adventure represents a 12 year fixed rate sterling loan at an overall cost of approximately 3.3% per annum fixed, backed by an export credit guarantee. The loan value of approximately £295m will be repaid in 24 broadly equal instalments, with the first payment is due 6 months after delivery.

I haven’t found the exact price for the first ship but as it is a “sister ship” with similar specifications I guess the price tag will be the same.

Now the problem is the following: The loans for financing the ship don’t seem to be “ring fenced”. In the Investor presentation the headline reads: “SHip financing is asset based” but then they state the following:

Ship financing is asset backed
• Asset backed financing for each new shipwith a 12 year amortizing ECA backed
loan:
– SofD: £245m, interest rate 4.4%
– SofA: c.£280m, interest rate 3.3%
• Covenants apply at the Travel sub-group first, and then Plc
• All covenants have significant headroom

So the Group actually is subject to covenants of the loans for the ship financing which in my opinion is a very unfortunate set up. Combined with the increased dividend payout I really don’t like the capital management of the Group as this burdens a very nice brokerage business with the risks of a relatively mediocre cruise ship business.

On top of that they have a relatively large pension DBO (300 mn GBP) which at the moment is “fully funded” on accounting basis but another risk factor at Corporate level.

Perosanlly, to me this looks like a “Too risky” set-up. “full recourse” leverage in such an extent on top of the pension plan is clearly a no-go for me despite the in principle quite attractive business model and the cheap valuation.

Summary

Although I like the company and its history  and the combination of Travel & Insurance & “Affinity Group”, I do not want to invest here, despite the relative cheap valuation. I do think the risks via the full recourse cruise ship financing outweigh the potential upside and I am also not fully convinced of Management’s capital allocation & mangement abilities. There is still a tail risk with regard to Brexit and there might be better UK “Pure plays” to speculate on a better Brexit outcome.

I think there is also the risk of potential disruption in the insurance space as there will be a new breed of “customer focused” Direct Insurance start-ups coming which might especially appeal to Saga’s current client group.