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Saga - dividend suspended, new terms agreed with lenders

Sophie Lund-Yates, Equity Analyst | 2 April 2020 | A A A
Saga - dividend suspended, new terms agreed with lenders

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Saga plc Ordinary 1p

Sell: 19.79 | Buy: 20.12 | Change -1.24 (-5.64%)
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Due to COVID-19 Saga is at risk of breaching agreements with its lenders, known as "covenants", if disruption to trading continues beyond September. To reduce this risk the group has suspended its dividend payments and negotiated new covenants with its bankers.

Saga's Travel business has suspended its Cruise and Tour operations, while the Insurance business has been largely unaffected by the pandemic.

The shares fell 5.0% following the announcement.

View the latest Saga share price and how to deal

Our view

Saga is facing very serious challenges.

The Travel division has essentially been shut down until at least May, and in all likelihood longer. Management thinks it can weather this disruption if it lasts around six months and demand recovers slowly after that. This means relying entirely on the Insurance division, the group's cash reserves and available credit.

However, if the division is unable to restart operations in September the group risks breaching its covenants. This would push the group into a technical default.

To try and avoid this outcome management has renegotiated its covenants on fairly punitive terms. If the net debt (debt minus cash) to cash profits ratio, excluding the cruise division, rises above 3.0 times Saga will not be allowed to pay any dividends to shareholders.

Furthermore, it must pay down its debt aggressively to reach this target. The repayment schedule means the group may be required to dedicate all cash profits to debt repayment. This could leave almost nothing to invest in the business for the foreseeable future.

The group's bankers have in one sense been reasonable in renegotiating, but they are standing by to extract far more than just a pound of flesh in compensation.

If the disruption is over by the end of summer the group will have suffered a severe wound, but will probably survive and eventually return to profitability, and shareholders could be rewarded for weathering the current storm.

But if the disruption continues, or high profile coronavirus outbreaks on cruise ships have permanently reduced demand, the group is in real trouble. If net debt approaches the maximum allowed, then the group will be unable to invest properly to restore what was, frankly, already a struggling business - and the lack of investment could hamstring operations in the long run.

While attention may be focussed on the embattled Travel division, Insurance is equally important. It will be providing the cash profits that net debt is measured against. Mercifully, COVID-19 isn't having any real impact on this division, but it's still not in the greatest shape.

Personal insurance is a tough market to be in, and increased price transparency and ease of switching has made it increasingly difficult to stand out. We've worried for some time that Saga's brand doesn't resonate with the younger end of its 'over 50s' customer base, and the damage to the cruise division may make this worse.

To makes matters worse the group had to write down the value of past acquisitions by £383m. This is mostly because the value attributed to these acquisitions is modified by their perceived risk. This risk is measured, in part, by Saga's share price, which has fallen yet further since January when this was last measured. Therefore, if the share price fails to recover, we expect more of these write downs in the future. To be clear, this has no implication for short term cash flow or the group's immediate financial position.

In our opinion, an investment in Saga hinges on the length of the COVID-19 disruption. If it's short lived the group might get back on its feet, but if not the group may suffer a blow it is unable to fully recover from.

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Operations update and review of financial position

Financial position

As of 31 March Saga had £92m of available cash, including £14m from the recent sale of two fringe healthcare business and £50m drawn down from the group's revolving credit facility. A further £50m remains undrawn. Saga expects to receive a further £23m in June from the sale of Bennetts Motorcycling Services.

Additionally, the Tour Operations business has £55m of ring fenced cash to cover £69m of advance customer receipts, of which £45m relates to departures between mid-March and June. Advance Cruise receipts total £41m, of which around £27m relates to departures this year. The group does not think it will need to refund all advance receipts as some customers are expected to accept discount vouchers for future departures.

The group has no repayments to make on its term loans until a £20m payment due 31 January 2021. However, the group must make two £10m payments for the spirit of discovery this year.

If Travel is suspended for six months until around September, Saga expects to remain in a "strong" financial position. However, if the disruption were to continue beyond this point the group risks breaching a debt covenant that requires net debt to remain below 3.5 times cash profits, excluding the cruise division.

Saga has therefore renegotiated these covenants to allow net debt to reach 4.75 times cash profits until April 2021, at which point the group must start paying this down to reach 3.0 times by July 2022. Net debt is currently 2.4 times cash profits, and stood at £593.9m on 31 January 2020, up from £391.3m a year earlier.

No dividends can be paid when net debt is above 3.0 times cash profits.

Operations

While Saga's Motor and Home Insurance business is unaffected by COVID-19, sales of travel insurance and the PMI product may be impacted. The group's new three year fixed price policies now make up over 20% of the policy book, and over 60% of direct customers choose the new policies. The shift back towards selling directly continues, and direct sales comprise 57% of total insurance sales.

Motor and Home policies decreased 2.9%, but margins were ahead of expectations at £74 per policy. The in house underwriters are expected to generate £40.6m in profit before tax, compared with £86.7m last year, with a combined ratio (the percentage of premiums paid out in claims and costs) of 83%. The underwriters had a solvency ratio of around 160% as of 31 January, but this is expected to have dropped to around 140% as the value of assets has fallen in recent months.

The insurance broking division is expected to make £90.2m in underlying profit before tax, down from £105.8m the year before.

The insurance business remains cash generative.

Weaker demand in Travel has accelerated due to the impact of COVID-19. The new ship, spirit of discovery, had a successful first six months, and generated cash profits of £20m in the second half of the year. The next ship, Spirit of Adventure, is expected within the next 12 months, although there is some uncertainty over the exact delivery date.

Due to government advice Cruises have been suspended until May and Tour Operations for a period of six weeks starting 16 March. However, the group warns that it is likely the suspensions will continue beyond May.

Saga expects to report a loss after tax of £312.8m for the year ending 31 January 2020, largely thanks to large non-cash write downs in the value of past acquisitions.

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