In all the fuss about the departure of Bob Mackenzie as chairman of the AA for gross misconduct, it is easily missed that the fourth emergency service, as the AA likes to think of itself, accompanied this with a nasty warning on this year’s performance.
This is what drove the shares back by 34½p to 210p on Tuesday, though yesterday they rallied mildly, up 1½p at 211½p. They were floated at 250p in June 2014, laden with £3.3 billion of debt by the AA’s former owners, the private equity groups Permira, CVC and Charterhouse. It is fair to say that those owners, as well as running up that level of debt, had not invested in the business as well as a careful owner might have.
The team of roadside engineers was run down, standards suffered and about 800,000 customers left over a five-year period.
Encouragingly, that trend reversed in the financial year to January, when paid personal members grew from 3,331,000 to 3,335,000, the first growth since 2010. That might not seem much but Tuesday’s trading statement indicated that although membership would be down a bit at the halfway stage, it would still be up year-on-year.
It is therefore worrying to learn that in June and July there were “erratic load patterns on an inherently fixed cost base”, which basically meant they ran out of engineers again and had to call in assistance from elsewhere, raising costs and hitting margins.
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There were other one-off hits, including an increase in the number of insurance policies being underwritten in-house, which clips profits this year for accounting reasons although it is generally good news longer term.
The consequence is that earnings before tax, interest and other one-offs, which were expected to rise to £413 million according to the City’s consensus, will be in line with the £403 million announced for the last financial year.
The AA has been trying to grow its insurance and driving services side, basically driving schools and teaching police and other professional drivers, but a generally positive note from the broker Liberum after the trading statement makes it clear that growth both here and in the core roadside services business will be slow. Part of the problem with the latter is that we are increasingly buying cars on credit terms which include roadside assistance as part of the package.
The Liberum note spells out some positives, including the fact that more people have heard of it since the float. Improvements in IT will mean savings of £40 million or more.
The negatives are spelt out in a generally downbeat note from Canaccord’s Quest analytical business, which raises a number of “red flags”, not least the persistence of one-off items distorting the profits line. The real negative is the level of debt, £2.7 billion at the financial year end and, one must assume, will not be much changed when the AA reports halfway figures on September 26. This is despite £200 million raised from a placing in 2015 and the sale in 2016 of the Irish business for £130 million.
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It is tempting to think that in debt terms the AA engine is straining mightily to get to the top of the hill while that slow rate of growth does not suggest much scope to coast gently downhill once it gets there.
The float price does not look like being reached again in a hurry even if shares sell on a fairly modest multiple of less than ten times this year’s earnings. There is also the concern the new management may elect to wipe out those debts more quickly by raising fresh equity from investors. These include Neil Woodford, the biggest instutional shareholder, with 12 per cent.
MY ADVICE Avoid
WHY It is possible that the new management will take bold action to wipe out debts by calling on investors to raise fresh equity
RSA Insurance
The perversity of the market again: there is not a lot to complain about in the halfway figures from RSA Insurance. The restructuring that was carried out by Stephen Hester since he joined in 2014 is over, with the sale of the UK legacy closed funds achieved this year.
The core operating ratios in the three divisions are all in positive territory, the UK and international side on the right side of 100 per cent, even after taking out the hit from the cut in the Ogden discount rate used to calculate compensation to serious personal injury claimants, which affected the industry. The core operating ratio is the difference between payouts to policyholders and income received, including that made on investments. Anything below 100 means the insurer is in profit.
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The Scandinavian business, more than half of RSA, came in with a ratio of 82 per cent, which is about as healthy as it gets for an insurer. The market is undeniably difficult but the company is seeing some improvement in premiums written, up 3 per cent excluding currency effects, reflecting 1 per cent volume growth and 2 per cent in pricing.
The Solvency II ratio, the difference between those funds that might be needed and the amount available and the main measure of insurers’ financial health, is 163 per cent and running ahead of RSA’s target of 130 to 160 per cent. The underwriting profit from the core insurance operation is at a record £222 million, up 28 per cent on last year.
Underlying earnings per share are ahead by 31 per cent. The interim dividend is likewise up 32 per cent. The shares, though, fell by 3p to 654p because of disappointment over that payment.
That Solvency II ratio would suggest a return to investors is possible next year, in the form of a share buyback or special dividend, but Mr Hester is being cautious. RSA has overpaid to investors in the past and was forced to cut the payment.
The fact is that the shares, at a low of well below £4 at the start of last year, look expensive on one measure — the premium to net tangible asset value of 2.4 times, while the forward dividend yield is only a little over 3 per cent.
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MY ADVICE Take profits
WHY Further prices rises are not certain