Say what you like about recent performance, Neil Woodford’s certainly not afraid to go against the grain.
Back in February, the star fund manager increased his holding in troubled roadside recovery and insurer AA (LSE: AA) after it downgraded profit forecasts and slashed its dividend to invest in and grow the business.
Will this gamble pay off? While market reaction to this morning’s full-year results suggests the worst might be over, I’m still wary of the stock.
Let’s look at the numbers in a bit more detail.
“Solid performance”
Revenue rose 2% to £959m in the year to the end of January. Broken down, the vast majority of this (£814m) came from the AA’s Roadside division. Here, new memberships increased by 7% although paid membership dipped 1%.
According to the company, more than 1 million members have downloaded its breakdown app and used it in just under 30% of incidents. Car Genie — AA’s intriguing technology that could help predict when mechanical problems might be encountered — has also been employed in 6,000 vehicles since being launched last August.
AA’s remaining revenue came from it Insurance arm, which rose 11% thanks to a focus on the “core products” of motor and home insurance (with a slower-than-anticipated decline in the latter).
In line with guidance, earnings before interest, tax, depreciation and amortisation (EBITDA) fell 3% to £391m.
Having delivered what he labelled as a “solid performance” last year, CEO Simon Breakwell assured loyal holders that AA had also made a “positive start” to 2018/19, adding that its board remains “confident” that its financial requirements are “well funded”.
Taking into account the aforementioned investment, the company reiterated its prediction that earnings for the next financial year would be somewhere between £335m and £345m. It expects to remain cash generative in 2019 with free cash flow targets of over £80m in FY20 and “in excess of £100m per annum thereafter“.
Patience required
Since a lot of negative news was arguably already priced-in, it’s perhaps no surprise that AA’s shares were sharply higher this morning.
Despite this, there’s no getting away from the fact that debt levels remain seriously high and that AA’s road back to health will be anything but short (assuming it isn’t acquired beforehand). While the cost of borrowings has been “reduced“, net debt still stands at 2.7bn — almost four times the current value of the company (£700m).
Confirmation that the total dividend has been slashed 46% to just 5p per share also means that investors aren’t really being adequately compensated for the risk they are taking. Worse still, this payout will now be reduced to 2p per share per annum from the next financial year “until profit and cash flow enables a change in the policy”.
There’s also the small matter of the company facing a £225m damages claim from ex-executive chairman Bob Mackenzie, sacked from last year for gross misconduct following a brawl with a colleague. Although AA expects to be successful in this case (and will attempt to recover the estimated £1m in legal costs in damages), this is not the sort of situation I’d really want hanging over a business that I part-owned when there are so many better opportunities elsewhere.
At around 7 times trailing earnings, shares in AA certainly look dirt cheap but surely only the most patient value investors — such as Woodford — need apply?
