Could Saga shares be long-term winners?

By focusing on customers in the prime of life, Saga (LSE: SAGA) looks for the long term. That fits with my own approach to investing. After a few years, there are signs of improving business trends for vacation and insurance providers. Should I put Saga shares into my portfolio?

Stock performance is volatile

For some investors who bought in the last year and a half, the results have been very strong. Between October and February, for example, Saga shares increased in value by more than 150%. Since then, however, they fell back over 30%. Over the past year, the stock has fallen 46%.

Today saw the company announce its unaudited preliminary results for last year. As I write, the stock is down about 8% in response.

Mixed business trends

These reactions may indicate bad results, even if they are not terrible.

I think they are a mixed bag. On the positive side, annual revenue increased by 54% to over half a billion pounds, while the company moved from loss to profit at the underlying level. With the demand for return trips in large numbers, the division saw its annual revenue increase by more than tenfold. The company also reduced its net debt by 2%. It’s a small reduction – but I see it as a step in the right direction.

However, not everything looks good when it comes to business.

Net debt stands at £712m. The pandemic and related restrictions are harmful to businesses that focus on selling travel and insurance to groups of people who are not in peak physical condition.

Borrowing helps Saga through dark times, but at some point the debt must be repaid. As interest rates rise, £712m is a sizable debt pile for a company that generated an underlying profit of £22m last year.

The headline loss was also considerable, at £259m after tax. However, which is largely driven by goodwill accounting writedowns in the insurance business, reflecting the changed environment in the business. Saga was actually cash flow positive last year.

What share of the bargain?

I have always liked the business model thanks to the focus on specific, underserved and often well-heeled customer groups.

As a return to the underlying profit shows, Saga is in recovery mode. I think the business can do well in the future. But as an investor, my concern is the debt burden. Saga has a market capitalization of just £175m – less than a quarter of its net debt.

For Saga stock to do well in the long term, I think there needs to be a sustained business recovery and substantial debt repayments. This may happen in the coming years, but it is not reliable.

The pandemic shows the severity of Saga’s business model in the event of an unexpected collapse in travel demand. A sudden downturn in the travel market remains an ongoing risk. Meanwhile, debt service costs may increase in the current interest rate environment.

So, although I like the underlying business model, the balance sheet makes me not buy Saga stock.