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Why I rate the Saga share price as a buy

The Saga (LSE: SAGA) share price has been on a roll recently. After the stock plunged to an all-time low of 33p per share in June last year, it has since risen by around a quarter as investor sentiment has improved.

It seems that this trend will continue.

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Growth struggles

Saga’s growth vanished after the company decided to reorganise its insurance business in 2017. Over the next two years, management worked flat out to try to restore investor confidence as well as attract consumers back to the brand.

The firm launched a new savings products and ploughed money into its cruise business, which is just getting off the ground. Recent trading updates from the business show that these efforts are now starting to pay off.

The insurance broking business, which caused all the trouble initially, is starting to claw back customer loyalty. Customer retention for Saga’s home and motor insurance division increased to 75% between August and the end of January 2020, up around 2% year-on-year.

Meanwhile, 57% of customers came to the group for insurance products directly rather than 50% in January last year. This should help Saga’s margins. It means the company pays less commission to other brokers.

The growing travel business is complementing the recovery in insurance.

Saga launched its first cruise ship last year, and management expects the vessel to generate EBITDA of £20m in its first six months of operation. Another is on order for August 2020.

Management believes both of these ships can generate up to £40m each in EBITDA over the long run.

Undervalued

These numbers show that while Saga is not back where it was just yet, the business has stabilised. That’s good news for the stock price going forward.

Indeed, the current valuation of the stock seems to suggest that the market is sceptical of Saga’s growth potential. The stock is currently dealing at a price-to-earnings ratio (P/E) of 5.4.

However, now that the company has stemmed the bleeding, it should start to attract a higher valuation.

The rest of the market is trading at an average P/E of 13. On that basis, the Saga share price seems to offer a wide margin of safety at current levels.

In addition to the stock’s low valuation, it also supports a dividend yield of 9.8%. The payout is covered twice by earnings per share, which suggests that it is here to stay in the near term.

Risk vs reward

All of the above implies that the risk-reward ratio of investing in Saga at current levels is attractive. The stock appears undervalued, and investors who buy the shares today will be paid to wait for the recovery.

Luckily, it looks as if the company’s recovery is already well under way. Over the next 12 to 24 months, the earnings from the cruise ship business should start to lift the bottom line, and any further improvement at the insurance arm will only add to the positive sentiment.

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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.