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The Saga share price: why I think it is worth buying for the dividend

The Saga (LSE: SAGA) share price has been a pretty poor investment to own over the past 12 months. Excluding dividends paid, the stock is down around 63% since the end of October last year.

But I think the tide is turning for this business. As a result, I reckon now could be a good time for risk-tolerant investors to buy the Saga share price for its capital gains and income potential.

Transforming the business

Saga’s share price has taken a hit thanks to problems at the group’s insurance business. Management’s decision to try to overhaul this business a few years ago stumbled, and the firm has been trying to get back on its feet ever since.

Progress is slow, but according to chief executive Lance Batchelor, who is due to step down in January, the company is making “good progress” winning back customers with its revamped insurance offering, cruises and savings products aimed at the over-50s.

Saga is pursuing several initiatives that are designed to bring customers back to the brand. These include a new three-year fixed-price insurance product and luxury travel offering such as escorted tours and riving cruising. Not only will these offerings help the brand differentiate itself, but they could produce better profit margins as well.

Unfortunately, it will take some time for these initiatives to flow through to the bottom line. First-half profits fell from £110m to £53m compared with the same period last year, but City analysts are expecting a recovery for the full year.

Analysts have pencilled in earnings per share of 7.7p for fiscal 2020, that’s up from a loss in fiscal 2019.

Dividend cut

Before the company announced its first-half results in mid-September, the stock supported a dividend yield of around 8%.

However, management decided to cut its half-year dividend from 3p per share to 1.3p. Analysts are expecting a similar cut for the full-year payout. While disappointing, even after the dividend reductions, shares in Saga will still yield 4.6%, and the payout will be safer than it has been for some time. Based on current forecasts, this dividend will be covered around 3.5 times by earnings per share, giving plenty of headroom if earnings should fall further.

The low payout ratio also gives management more free cash to invest back into the business, a long-term positive in my view.

The bottom line

So overall, following Saga’s recent dividend reduction I think it could be time to buy shares in this over-50s travel and financial services specialist. The new, lower dividend looks safer than the old payout and, at the time of writing, the business is changing hands at around 6.5 times forward earnings.

This valuation gives a wide margin of safety if anything goes wrong. I will be watching the company closely over the next 12 to 24 months as it continues to invest in the turnaround plan. I think these efforts to refine its customer offering have tremendous long term potential.

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Rupert Hargreaves owns no 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.