Could Saga shares be long-term winners?

Owning Saga shares has rewarded some investors handsomely in the past few months. Do today’s annual results tempt our writer to buy?

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With its focus on customers in the prime of life, Saga (LSE: SAGA) looks to the long term. That matches my own approach to investing. After a rocky few years, there are signs of improving business trends for the holiday and insurance provider. Ought I tuck Saga shares into my portfolio?

Volatile share performance

For some investors who bought in the past half year, the results have been very strong. Between October and February, for example, Saga shares increased in value by over 150%. Since then, however, they have fallen back over 30%. Over the course of the past year, the shares have sunk 46%.

Today saw the company announce its unaudited preliminary results for last year. As I write, the shares are down around 8% in response.

That reaction might suggest the results are bad, though not terrible.

I think they are a mixed bag. On the positive side, annual revenue jumped 54% to over half a billion pounds, while the company moved from loss to profit at the underlying level. With demand for travel coming back in a big way, that division saw annual revenues jump more than tenfold. The company also cut its net debt by 2%. That is a small decrease — but I see it as a step in the right direction.

However, not everything looks great about the business.

Net debt stands at £712m. The pandemic and related restrictions were disastrous for a business focussed on selling travel and insurance to a group of people many of whom are no longer in peak physical condition.

Borrowing helped Saga through dark times but at some point those debts will need to be repaid. At a time of rising interest rates, £712m is a sizeable debt pile for a company that made an underlying profit of £22m last year.

The headline loss was also sizeable, at £259m after tax. However, that was largely driven by an accounting writedown of goodwill in the insurance business, reflecting the changed environment in which the business operates. Saga was actually cash flow positive last year.

Are the shares a bargain?

I have always liked the business model thanks to its focus on a specific, underserved and often well-heeled customer group.

As the return to underlying profitability shows, Saga is in recovery mode. I think the business can do well in future. But as an investor, what concerns me is the debt load. Saga has a market capitalisation of only £175m – less than a quarter of its net debt.

For Saga shares to do well in the long term, I think there needs to be ongoing business recovery and substantial debt repayment. That may happen in coming years, but it is far from assured.

The pandemic showed the fragility of the Saga business model in the case of an unforeseen collapse in travel demand. Such sudden downturns in the travel market remain an ever-present risk. Meanwhile, debt servicing costs could increase in the current interest rate environment.

So although I like the underlying business model, the balance sheet puts me off buying Saga shares.

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.

C Ruane 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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