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One share on my ‘avoid’ list and what I’d buy instead

Figures in the full-year results report from AA (LSE: AA), the car insurance, driving lessons, breakdown cover, loans, motoring advice and roadmaps provider, make grim reading.

In the trading year to 31 January, revenue rose almost 2% compared to the year before, but most of the other important figures are down. Adjusted earnings per share slid by 32% and the directors slashed the total dividend for the year by 60%.

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Big liabilities

However, the big worry, for me, is the number for non-current liabilities, which includes gross debt and pension liabilities. It stood at a couple of million below £3bn on the last day of the firm’s trading year – that’s more than 13 times the operating profit AA reported for the year. If trading softens because of a general economic slump, I reckon the firm may struggle to keep up its interest payments and obligations.

The company is working hard to turn itself around and chief executive Simon Breakwell said in the report the firm is making “significant progress” one year into its strategic plan. He said new contracts with Lloyds Banking Group, Jaguar Land Rover, Volkswagen Group, Arval and others “firmly position the AA as the B2B partner of choice for Roadside.”

The company aims to build from a position as the leader in the market by delivering good customer service, growing the insurance business, and differentiating the AA from other providers by using “digital capabilities and investment in connected car solutions.”

I think the task of turning around the AA and growing the business is a mighty one. Meanwhile, the cyclical risks in the sector remain large and potentially exaggerated by the big load of debt on the balance sheet. So although the AA is a well-known name, the company’s shares will stay on my ‘avoid’ list.

I’d buy ‘the market’ instead

AA’s market capitalisation sits close to £554m and the firm is a constituent of the FTSE Small Cap index. This is one of those occasions when I’d rather have diversified exposure to the entire market than a concentrated investment in this one individual share. So, I’d look at the possibility of investing in one of the all-share tracker funds such as the Aberdeen UK All-Share Tracker Class B – Accumulation, or perhaps the BMO FTSE All-Share Tracker Fund Inclusive – Class 1 – Accumulation.

Alternatively, you may be more comfortable with an FTSE 100 index tracker fund or one that follows the fortunes of the mid-cap FTSE 250 index.

I reckon having at least some of my funds invested in a tracker within my portfolio is a good way to keep focus. It helps ensure that my individual share-picking strategy is working and actually beating the compounded returns available from the wider market. If the tracker beats the returns from the rest of my portfolio over time, what’s the point of putting all the effort into researching and monitoring individual share investments?

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Kevin Godbold has no position in any share 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.