Do soaring sales make Saga shares a no-brainer buy?

After trebling in a few months, Saga shares have rewarded investors with one of the year’s better recoveries. How much more is there to come?

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Investors looking for an impressive recovery story need check no further than Saga (LSE: SAGA) shares. The price has climbed 150% since a 52-week low in October 2022.

The shares got an extra boost from a full-year update this week. The company said it “expects to report significant growth in revenue“. That should amount to an increase of between 40% and 50% compared to the prior year. And it’s thanks to a recovery in the cruise and travel business.

Profit before tax should be between £20m and £30m. That’s still some way short of profit levels from before the pandemic. But considering the added pressures from inflation and interest rates, I think it’s an impressive performance.

Disposal

In other news the same week, the company confirmed it’s discussing the possible disposal of Acromas Insurance Company.

That highlights what I see as one of Saga’s key long-term strengths. It’s not just a cruise and travel operator. That can be a capital-intensive business, and can lead to a lot of debt on the balance sheet. At the halfway stage at 31 July, Saga reported net debt of £721m. For a company with a market cap of just £256m, I find that seriously concerning.

As well as the risk brought by debt during tough economic times, it makes share valuation harder. For the year ending 2024, forecasts put Saga on a price-to-earnings (P/E) multiple of under seven. On the face of it, that might make it look like a screaming buy.

Adjusted valuation

But by including net debt in the calculation, we can arrive at an adjusted P/E for the business itself. Based on the same 2024 forecasts, it comes out at around 25. Suddenly, it doesn’t look like quite the no-brainer any more.

The P/E should hopefully keep coming down if Saga’s recovery continues to make progress. But that recovery needs to span a dark economic period. High inflation, high interest rates, supply chain problems, geopolitical strife… all will surely be with us for some time yet.

Business model

Against that background, I do like the insurance side of the business. It’s potentially less capital intensive, even if still a bit pressured by an economic squeeze. I’m not too worried by the possible disposal of Acromas, which Saga says underwrites around 25%-30% of its insurance business.

The company reckons a disposal would still be “in line with the evolution to a capital-light business model and the stated objective to reduce debt“.

Verdict

So, does Saga’s recovery make it a no-brainer buy? Well, I think the economic risks it faces keep it well away from that description for me.

I like the evolution of the company, and its diversification into travel-related services. But the valuation holds me back, particularly when I account for debt.

We’ve seen numerous tentative recoveries recently that fell back again. And I can’t help fearing that this might turn into another. I do believe I see long-term potential, but I’ll wait for the short-term risks to play out.

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.

Alan Oscroft 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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