Can AA plc Rescue Your Portfolio Or Should You Buy Auto Trader Group plc Instead?

Roadside assistance firm AA (LSE: AA) has had a bumpy ride over the past year. Its shares have fallen by almost 33% in the past 12 months raising the question of whether it’s a potential recovery play. Or if you want to rev up your portfolio, should you buy Auto Trader (LSE: AUTO) instead? 

Driving ahead

The AA is the UK’s largest breakdown cover organisation and one of the country’s best-known brands. But interim results for fiscal 2016 didn’t look good with a drop in revenue to £484.6m from £491.7m, and a pre-tax loss of £63.6m, compared to a £10.2m profit a year earlier. Earnings per share also fell, to 8.2p from 11.51p. Does the future look bleak for this instantly recognisable brand?

Executive Chairman Bob Mackenzie doesn’t think so and stayed upbeat about the company’s prospects, saying: “The AA has once again demonstrated its fundamental strength, stability and hugely cash-generative characteristics. We are confident that we are in line with expectations for the full year and that we will position the AA as the digital brand for all motorists’ needs.”

Bob Mackenzie is confident and City analysts seem to agree. So given that less than a year ago the shares were trading at 434.5p and can now be snapped up for 271p, it could be a good time time to grab a bargain.

Analysts expect earnings to slide by 10% to 20.84p for the year to 31 Jan 2016, but they’re looking for this to be followed by growth of 16% and 15% for 2017 and 2018, respectively. This represents a forecast P/E of 13 for FY2016, falling to 11 and 10 for the following two years. In addition, healthy dividend yields of 3.3%, 3.8% and 4.3% are forecast for the next three years.

Those analysts are clearly expecting a turnaround in fortunes and I think a forecast P/E of 10 for 2018 represents exceptional value. Bargain hunters may want to take a closer look at the shares as there’s significant upside potential given the earnings outlook. The generous dividends should keep income investors happy too!

High priced hotshot

Auto Trader is the UK’s largest digital automotive marketplace and sits at the heart of the country’s vehicle buying process. In recent months, shares have slumped from a high of 455p in December 2015 to current levels of around 380p. Consensus forecasts suggest a 195% rise in earnings to 12.17p for the year ending 31 March, followed by further growth of 17% and 15% in the following two years. Auto Trader currently trades on 31 times forecast earnings for this year, falling to 27 and 23 times for 2017 and 2018.

Brokers are optimistic about the company’s growth prospects with US investment bank Goldman Sachs recently reiterating its buy recommendation with a price target of 443p. However I think that at 23 times 2018 forecast earnings, the stock isn’t cheap and the shares could tumble if the ambitious growth figures aren’t realised. I would avoid the shares for the time being.

At present levels, the AA represents exceptional value and could be a good recovery play with the added bonus of generous dividends, while Auto Trader seems a little too risky for my liking. I think there are better opportunities for growth elsewhere.

With this in mind, the experts at The Motley Fool UK have unearthed A Top Growth Share that has the potential to deliver stunning shareholder returns.

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Bilaal Mohamed has no position in any shares mentioned. The Motley Fool UK has recommended Auto Trader. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.