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Why Saga’s 7% dividend yield could be the buy of the decade

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Last week’s final results from Saga (LSE: SAGA) won a positive reception from the market. In a moment I’ll explain why the shares could still be cheap, but first I want to look at another out-of-favour insurance stock I rate highly as a potential income buy.

Sure enough

Sales at motor and home insurer Esure (LSE: ESUR) have risen by 36% to £781.3m since the group’s flotation in 2013. But tough market conditions mean that profits have stagnated over the last five years.

Indeed, last year’s after-tax profit of £80.4m was actually lower than the £93.2m earned by the group in 2013. As a result of this weaker performance, the firm’s share price has fallen by more than 25% since July, returning to its IPO level of about 215p.

I think this could be a buying opportunity. The company’s finances remains in good health and earnings per share are expected to rise by around 10% in both 2018 and 2019.

With the stock trading on just 10 times forecast earnings, I think any improvement in profits should be reflected in a rising share price.

Analysts also expect the firm to pay out 14.2p per share in dividends this year, giving Esure a prospective yield of 6.6%. I rate the shares as a buy.

What a Saga

At the time of Saga’s profit warning in December, I cautioned that “I don’t see any need to rush in here”. This view proved correct, as the shares then fell by a further 23%, hitting a 52-week low of 108p in March.

The Saga share price has since risen by around 15%, but at 125p, the stock is still worth about 30% less than at the start of December. Last week’s results gave us a much-needed opportunity to learn more about the state of the firm’s finances.

The news was mostly good, in my opinion. Pre-tax profit from continuing operations fell by 7.6% to £178.7m, mainly due to lower profits from insurance. But profits from travel operations rose by 36.9% to £20.4m, giving some credibility to the firm’s plans to increase travel profits “four or five times” by 2022.

The full-year dividend was increased by 5.9% to 9p, rewarding shareholders who’ve held onto the stock.

What happens next?

Saga’s hope is that profit from travel and other services will continue to rise, reducing its dependence on insurance.

The group is developing a loyalty programme to encourage customers to buy more than one service from the firm and also plans to spend £10m on extra marketing in 2018. According to last week’s results, this is already generating results. Sales of new motor and home insurance policies have risen by 17.7% and 9.2% respectively, so far this year.

Good fundamentals

My reading of last week’s figures is that Saga remains in quite good financial health. Last year’s free cash flow of £125m covered the £98.8m dividend payout comfortably, and net debt fell by £32.9m to £432m.

If the group can maintain stable insurance profits and continue to increase profits from travel, then I believe the dividend should remain affordable at its current level.

Saga shares now trade on a forecast P/E of 9.2 with a prospective yield of 7.2%. After reviewing last week’s figures, I’d be happy to buy.

Buy-And-Hold Investing

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Roland Head 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.