Here’s a puzzle for you. A firm takes home £199.2m in earnings for the six months to the end of July. It has no significant asset impairments in that time and didn’t splash out on any major capital expenditure, but still reports a loss of £63.6m. Why?
If you learn the firm’s name is AA plc, the answer will probably become clearer: debt. Lots and lots of debt. The motoring services firm still owes £2.8bn (or around seven times annual earnings) as a legacy of its days under private equity ownership, when it was merged and subsequently demerged with Saga.
Interest payments on that debt remain understandably huge, meaning its earnings (for some reason, the firm likes to talk about EBITDA – earnings before interest, tax, depreciation and amortisation) have dwarfed its reported profit (or in this case loss) since its management buy-in and IPO last year.
The reason the AA suffered a £63.6m loss this half, compared to a £10m profit for the same period last year, is largely that it’s trying to rescue itself from its perilous debt mountain before being hit by the storm of rising interest rates.
The firm had exceptional refinancing costs of £87.4m over the period, which was the price it paid to pay off its most expensive debt by issuing £735m of bonds, while also raising a further £200m of equity. The result is that net debt fell from £2,967m to £2,811m, with an annual saving on interest payments of £45m.
A definite improvement, surely, but not yet transformative. Still, the AA’s underlying performance remains strong, despite a 1.4% dip in revenues to £484.6m, which was the result of a decline in its insurance services business. Its ongoing decline in personal member numbers is slowing, while its main roadside assistance business is growing.
The firm’s 6% drop in earnings reflected both this and ‘distortions’ primarily from investments in marketing and new technologies. Executive chairman Bob Mackenzie also sees trouble ahead with the government’s 58% Insurance Premium Tax hike, which will increase the dreaded churn in its business when it comes into force this November, and EU rules on holiday pay which he expects to increase costs.
Mackenzie was quick to strike an upbeat note, however, pointing to the positive effects of the firm’s ‘transformation’ (modernisation of its IT systems, improved digital offerings such as the AA route planner, a move into insurance underwriting and a step-up in brand marketing), which he said will make its impact felt in 2017.
‘The AA has once again demonstrated its fundamental strength, stability and hugely cash generative characteristics,’ he said.
Neither that nor the AA’s announcement that it will start paying dividends to the tune of £55m this year seems to have assuaged worried investors however. Shares spluttered this morning on the news, dropping 9% to 303.1p by late morning - though that's still well up from its 250p list price.