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Why I’d avoid Saga plc and buy this 6% dividend yield instead

It has been a lousy month for insurance and travel group Saga (LSE: SAGA). Shares in the company crashed by more than 25% last week after it issued a profit warning for this year, and 2018. 

Following this double profit warning, shares in the company have lost more than 35% year-to-date. Unfortunately, it looks as if this decline isn’t going to go into reverse any time soon at Saga’s key division, with its insurance business under attack from a “meaningful, significant step up in the competitive environment” that it reported for the fourth quarter. 

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With this being the case, while shares in Saga have now fallen to a relatively attractive multiple of 10.1 times forward earnings, I believe the valuation seems relatively appropriate for a business that’s struggling to grow. 

What about the income? 

The one bright spot is the group’s 6.8% dividend yield. Looking at current City forecasts, I estimate that this payout is covered 1.5 times by earnings per share, which gives headroom for flexibility if earnings fall further. Management expects profits to rise by 1% to 2% this year, before falling 5% next year so based on these figures, it does not look as if the payout is going to come under threat anytime soon. 

And looking out to 2020, management is more positive about the group’s outlook. Towards the end of the decade, Saga expects a “double tailwind” of growth as new customers deliver profits and new ships boost the firm’s travel division. 

Still, plenty could go wrong between today and 2020, and I’d rather invest my hard earned money in a business with a brighter outlook, and more attractive valuation. 

A better value buy? 

Over the past year, oil services business Petrofac (LSE: PFC) has really proven itself. Even though the firm is under investigation by the Serious Fraud Office regarding bribery allegations, year-to-date, the company has received $5.2bn of new orders, which leads me to believe that customers still trust Petrofac to deliver high-quality projects, and are more worried about this than the investigation. The group’s order backlog was $10.3bn at the end of November, compared to $11.7bn at the end of last year.

Petrofac’s management has also made a concerted effort to strengthen the group’s balance sheet. Net debt is projected to fall to $850m at year-end, compared to $1bn at the halfway mark according to today’s trading update. 

Based on these upbeat trading figures from the firm, I believe that the City’s current guidance — for earnings to fall 21% in 2018 — is a tad too pessimistic. Of course, the one big unknown is the scale of any fine the SFO might levy on the business, but hopefully, any settlement will be negotiated to be paid in a way that does not cripple the company. 

All in all, I think Petrofac could be an attractive investment at current levels. The shares are currently trading at a deeply discounted multiple of 5.7 times forward earnings and also yield 6.3% — the payout is covered nearly three times by earnings per share.  

A better growth buy? 

Admittedly, Petrofac might not be for everyone as while the shares are cheap, the investigation by the SFO will likely overshadow the business for some time.

So, if you're not interested in this undervalued income play, you should check out this free report from our top analysts.

The report details an opportunity that our analysts believe could yield gains 50% or more from current levels, despite its rally over the past few years. 

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK owns shares of Petrofac. 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.