AA - changing the engine oil

AA (AA..L): As a mature, well known brand it should be expected that the AA pays a dividend. In these interims, to 31^st July 2015, it has done just that, but this hasn’t pleased everyone. The nub of the debate is whether, in a period of corporate re-generation, cashflow should be used to pay down debt further, before paying shareholders. The AA came to market in 2014 with a full load of debt but in July of this year they completed a re-financing of debt. This saved £45m p.a. of interest but only cut net debt (including a chunky pension deficit) to trading EBITDA from 6.9x to a still chunky 6.7x. At the time the company said that they would now be able to pay dividends totaling £50m in FY2016, so a tad more than the interest savings. They have now tweaked this up to £55m, or 9p per share, of which 3.5p has been declared as an interim. This optimism is backed by 111.8% cash conversion in the period, as working capital was squeezed hard.

However, a quick look under the bonnet has some worried that the AA spark plugs might be a bit damp. Interim revenue fell 1.4% and trading EBITDA fell 5.9% to £199.2m, with adjusted eps down 29.3% at 8.2p. In a post private equity ownership catch-up, the IT systems (with SIX customer databases) are being over-hauled and money is being spent on halting the decline in individual members, whilst the insurance and financial services offerings are being re-booted. The benefits of all this “will not begin [to be seen] until the latter half of the 2017 financial year”. They do then lob in the caveat that investors need to consider the hits from the 58% Insurance Premium Tax hike this November and EU regulation on holiday pay.

The shares have been stuck in the slow lane of late, having fallen back by almost a third in six months, to 287p. On consensus eps of 21.3p for FY2016, the PE is 13.5x and the yield is 3.1%, with accelerating growth expected in FY2017. If the management deliver on their business plans then the current valuation is a good entry point, but the worry is that if they hit any speed bumps then the debt pile and the dividend expectations will stall the engine. There is just something about all this that is making me wary. (Neil Cumming^, 28^th September  2015)

These comments are not a personal recommendation to deal. Any investments can fall as well as rise in value, so you could get back less than you invest. I may have a financial interest in some of the stocks written about. www.dividendpower.co.uk or e-mail at info@dividendpower.co.uk  Twitter:  @DividendPower