Is AA a falling knife worth catching after today’s share price crash?

AA plc’s (LON: AA) latest results have disappointed the market but can the shares be considered a bargain? This Fool thinks not.

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Owners of battered roadside recovery firm AA (LSE: AA) aren’t having a good day.

Despite delivering a set of interim results in line with expectations, the mid-cap’s share price had fallen over 13% by mid-morning, firmly putting the brakes on the recovery seen since the beginning of April this year.   

When you consider just how ugly some of the numbers were, this reaction is perhaps understandable.

Profits slump

Although revenue climbed by 2% to £480m on the back of a “solid performance” in its Roadside and Insurance divisions, underlying EBITDA (earnings before interest, tax, depreciation and amortisation) fell 17% to £161m thanks to additional operating expenditure and higher costs.

The latter was primarily caused by the sharp rise in the number of callouts received by the company following the extreme weather experienced in the first half of the financial year. 

Factor in a 1% fall in roadside business retention (as a result of regulatory pressures and increased competition) combined with a 2% drop in membership and it’s not hard to see why some investors decided enough was enough. 

Even a more positive performance by its Insurance arm — where AA saw a 7% rise in motor policies — wasn’t enough to prevent group pre-tax profit diving no less than 65% to £28m in the six months to the end of July.

Not that this appeared to bother CEO Simon Breakwell. Reflecting on today’s numbers, he stated that the company was still “on track” to meet its earnings guidance of between £335m to £345m for the year “and to return to growth thereafter“. I’m not sure I share his optimism.

Trading at 8 times earnings before today, one might argue that AA was already a bargain for patient investors. Personally, I’d want to see signs of a strong and sustained recovery before venturing anywhere near. 

Despite taking steps to tackle its debts and reducing its pension deficit by £154m over the period, AA’s finances are still nothing like I’d want them to be. Moreover, the stock just isn’t rewarding from an income perspective.

Although already expected, the interim dividend was slashed by 83% to just 0.6p a share with the company sticking to its guidance of 2p per share for the total payout. Before today, that would have seen the company yielding just 1.7% in 2018/19. 

Paid to wait

In my opinion, investors content to bear the risk of investing in troubled companies should expect to be rewarded for their patience. That’s why I’d be more willing to purchase stock in insurance provider Saga (LSE: SAGA) than the AA at the current time. 

Although still unloved by the market following a profit warning last December, Saga’s shares do come with a forecast 7.1% dividend yield, covered an expected 1.5 times by profits.

While I would prefer to see a decently-growing dividend (Saga’s total payout is only expected to rise 2% next year), this is arguably better than AA’s offering which, of course, could end up getting cut completely if the promised return to growth doesn’t materialise. 

Right now, Saga’s stock changes hands for under 10 times earnings. That already looks a sufficiently large margin of safety in my book, although the reaction to tomorrow’s half-year numbers will be interesting. 

Even if the company has continued to underperform — leading to an eventual dividend cut — I think it unlikely that this will be as severe as that suffered by AA’s owners. 

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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