The AA’s (AA.) self-confessed historical underperformance has seen its shares lose over three-quarters of their value since listing on the main market in June 2014. Despite launching a strategic plan to reinvigorate its prospects following a profit warning last year, the market remains skeptical; rightly so in our opinion. The company is drowning in debt and its business could be hit by the outcome of a Financial Conduct Authority (FCA) market study into general insurance pricing practice. An interim report is due this summer with a full report by the end of the year. Against this backdrop, short interest is rising again. Having peaked at 12.6 per cent in March 2018, shorts subsequently slumped to 6.7 per cent last June but have now run back up to nearly 10 per cent.
Strategic turnaround plan under way
Business contract wins and renewals
Decreasing membership
Earnings and margin decline
High levels of debt
FCA insurance pricing study
Last year, AA's capital expenditure increased by over a fifth to £104m (including £30m in IT transformation and £13m to grow the roadside and insurance businesses) contributing to a worse-than-expected £22m free cash outflow. Meanwhile, trading cash profits (EBITDA) declined by 12.8 per cent to £341m. Additional strategic expenditure to attract and retain customers has squeezed profitability and the trading cash profit margin contracted by seven percentage points to 42 per cent.
Accounting for over 85 per cent of revenue, the AA’s largest segment, roadside assistance, has seen paid personal memberships continue to decline, slipping a further 2 per cent in the financial year to the end of January 2019, to 3.21m, and customer retention dropped by 1.6 percentage points to 80.3 per cent. Using costly third-party garages to supplement its patrol network remains a persistent crutch during periods of high demand, contributing to the six percentage point erosion of the group trading cash profit margin last year.
On a brighter note, the business-to-business operation retained or extended all key contracts due for renewal last year. A five-year contract renewal with Lloyds Banking is the UK’s largest roadside assistance programme, servicing around 2.4m customers. New business wins include a three-year contract with Arval in the fleet and leasing sector. Although average income per business customer increased from £20 to £21, customer numbers have declined by 1.4 per cent to 9.79m.
However, management foresees an inflection point this year. With capital expenditure dropping back following the completion of projects, the group is targeting £80m of free cash flow and a return to cash profit growth. Meanwhile, it is hoped an improved digital offering will help boost customer numbers, engagement and retention and return the group to membership growth next year. The expected progress underpins a target of reducing the net debt to cash profit ratio to three to four times in the medium to long term.
To us this looks quite ambitious given net debt has decreased by just 8.5 per cent in the past four years, while poor trading has contributed to net debt to cash profit soaring to eight times. Meanwhile, cash conversion (operating net cash flow as a proportion of trading cash profit) declined from 94 per cent to 87 per cent last year.
AA (AA.) | ||||
ORD PRICE: | 58.8p | MARKET VALUE: | £361m | |
TOUCH: | 58.7-59.1p | 12-MONTH HIGH: | 142p | LOW: 57.8p |
FORWARD DIVIDEND YIELD: | 3.4% | FORWARD PE RATIO: | 4 | |
NET ASSET VALUE: | * | NET DEBT: | £2.72bn |
Year to 31 Jan | Turnover (£m) | Pre-tax profit (£m)** | Earnings per share (p)** | Dividend per share (p) |
2017 | 933 | 167 | 21.3 | 9.0 |
2018 | 960 | 164 | 21.8 | 9.3 |
2019 | 979 | 115 | 14.9 | 5.0 |
2020** | 9911 | 112 | 14.7 | 2.0 |
2021** | 1,008 | 122 | 16.0 | 2.0 |
% change | +2 | +9 | +9 | |
Normal market size: | 20,000 | |||
Beta: | 1.456 | |||
*Negative shareholders' equity **Berenberg forecasts, adjusted PTP and EPS figures |