Saga (LON: SAGA) is considering whether to reduce its dividend, but this is not necessarily a bad thing. The debt burden is significant, and this does not help the share price.
Saga talks in its recent trading statement about capital allocation. This is financial speak for considering whether to maintain the dividend.
The insurance, travel and cruising company is keen to reduce the debt on its balance sheet and cutting the dividend will certainly help. The current yield is 8.9%.
The 2018-19 dividend was 4p a share and it has been assumed that this would be maintained for 2019-20 and next year.
However, the dividend has already been cut sharply from 9p a share in 2017-18. This has made a contribution to reducing borrowings.
The expected dividend could cost around £45m, although it depends on the take up of the scrip dividend.
At the time of the interims a medium-term pay out ratio of around 50% of underlying earnings was thought to be fair. This was expected to enable a reduction in borrowings over the next few years.
Net debt was £391.3m at the end of January 2019. The purchase of the Spirit of Discovery cruise ship means that net debt was £642.9m six months later. That is around two-thirds of NAV.
The change in debt would have been small without the inclusion of that £245m ship loan with a maturity date of June 2031. There is another ship due for delivery in August.
The nearest debt to maturity is a £160m term loan due for repayment in May 2022, while there is a £250m corporate bond payable in May 2024.
Despite declining profit there was still £24.9m of available operating cash flow after capital investment, excluding the ship purchase. This shows the cash generative nature of the business.
The insurance business is stabilising with new fixed price products offsetting declines in motor insurance. There is an increase in claims, though.
The cruise bookings are higher than expected, although package tours is a tough market. The Spirit of Discovery could make annualised EBITDA of £40m, which would help to reduce debt.
Underlying pre-tax profit is expected to be in the range of £105m-£120m. That excludes a £4m charge relating to Thomas Cook.
Saga will provide more news about the dividend and reducing the debt with its preliminary figures.
There is an argument that a high yield can help to hold up a share price, but there comes a time when the yield is so high that investors are not confident the dividend will be maintained or it does not matter to them anymore.
The share price has stabilised at around 40p-50p (currently 44.94p) in the past six months with a couple of attempts to move towards 60p. The shares are trading on six times prospective earnings.
More importantly, net assets are double the share price at 90p a share. Two years ago, the share price was around 200p.
There is value here, but a share price bounce depends on investor belief that the bottom has been reached and there will be improvement.
A flat profit is expected for 2020-21, rising to £128m in 202122. That would cut the multiple to five.
The shares appear to have reached the bottom, but it may be a while before the share price bounces back.