Set sail for profits with Saga

Saga, the travel and insurance brand, will profit from an ageing population, says Matthew Partridge.

917_MW_P34_Trading

Demand for Saga cruises has soared

Ayear ago this month Monarch Airlines collapsed. This was bad news for Saga (LSE: SAGA), the travel and insurance group, as many of its travel packages involved flights with the stricken airline. By December it was forced to admit Monarch's demise, along with tougher market conditions, had hit profits, causing it to undershoot expectations by a large margin. The shares promptly plunged by a third to 125p, and by late March had slipped to 110p. Since then the stock has rallied but it remains 30% below last October's level.

But the long-term outlook remains encouraging. One of the big factors in Saga's favour is demographics. Its business model is based on selling to affluent people over 50. Thanks to increasing life expectancy, the numbers of over-50s is on the rise. At the same time, older consumers are more active and adventurous than ever. Not only does Saga's illustrious brand make it hard for competitors to gain market share, but it also helps the group-sell related products.

Drumming up new business

Indeed, nearly half its customers now buy more than one of its offerings, with the average customer holding 1.7 products. Increasing this amount through various promotions is key to Saga's growth strategy. For example, over the past 18 months it has launched the Possibilities membership scheme, which aims to offers policyholders and customers discounts on a wide range of external services and products. So far this scheme seems successful, as more than 850,000 people have signed up for it. This has encouraged it to launch Travel Possibilities, a related scheme focusing on travel-related promotions. The core of its business is related to insurance, primarily motor, home and travel insurance. While this mainly involves acting as a broker between individuals and insurance firms, Saga also engages in some underwriting (older drivers tend to be low-risk as they drive more cautiously).

However, the most interesting segment of the business is its travel arm, where it's expanding its potentially lucrative cruise market. Indeed, demand has been so high it has been able to commission several new ships from scratch, with The Spirit of Discovery due to start sailing next summer and The Spirit of Adventure set to follow in 2020. While the company has taken on additional debt to finance the cost of these vessels, the increased cash flow should allow it to start paying down this debt, strengthening the balance sheet. Saga's valuation also looks attractive on a Q1 2019 price-earnings ratio of just 10.4. This is significantly less than other travel and insurance companies. It also has a very good yield of 7%. Overall, I'd suggest that you buy it at the current price of 137 with IG Index at £15 per 1p. You should put the stop loss at 102p. This would give you a total downside of £525.

Trading techniques... the carry trade

One popular trading technique is the carry trade. While this is a general term for borrowing money at a low rate and investing it in a higher-yielding, but riskier asset, it usually applies to the currency markets. You borrow a currency with low interest rates and buy one with high rates. For example, the benchmark US rate, the Federal Funds rate is now at 2%-2.25%, while the UK equivalent is only 0.75%. So if you bought dollars and sold pounds you would earn a spread of 1.50% on your money. The downside to the carry trade is that there is always a risk that the higher yielding currency will fall in value, reducing the value of your assets relative to your borrowings. For example, the Australian dollar once lost 25% of its value in 18 months against the lower-yielding Japanese yen. Overall, financial theory suggests that on average in a perfectly efficient market, the exchange rate should move in favour of the lower-yielding currency in a way that eliminates any profits from the carry trade (this is called uncovered interest rate parity).

However, the evidence seems to suggest that the carry trade is a workable strategy. A 2017 study by Kimberly A. Berg of the University of Miami and Nelson C. Mark of Notre Dame looked at 41 currencies between 1973 and the end of the 2014.

They found that a portfolio of high-yielding currencies (compared with the US dollar) would substantially beat a portfolio of the lowest-yielding ones. However, the portfolio of high-yielding currencies was more volatile, especially during times of economic uncertainty, which is why the carry trade is often described as "picking up nickels in front of a steamroller".

How my tips have fared

It's been a bad fortnight for our six long positions, with all of them declining. Greene King fell from 500p to 492p, Redrow dropped from 588p to 561p, Next from £56 to £54.26, Shire is now £43.67 (from £45.35) and Premier is 132p (135p).

Despite a double-digit leap in sales, Wizz Air fell through the stop-loss level of £26. The problem was that investors began to price in a pessimistic outlook for the sector after rival Ryanair posted a profits warning.

This means that we had to close out our Wizz position at a loss of £960. Even excluding Wizz Air, our current long positions are £375.50 under water.

However, the good news is that five of our six short positions also went down in price. Tesla fell from $301 to $251, Netflix has gone from $370 to $350, Snap from $9.12 to $7.48 and Just Eat slipped from 660p to 621p.

Twitter also declined slightly to $28.45 from $28.63. The only exception was bitcoin, which rose from $6,419 to $6,579. The upshot is that only Netflix is now making us a loss, and even then only by £98.

Overall, our short positions are making a profit of £2,020, outweighing both the losses on our current long positions as well as the £427 we've lost on our closed positions.

At the moment, only our bitcoin short (issue 880) and Greene King long (issue 891) have been held for more than six months. Since they are making a profit, I'm going to recommend that you stick with them.

I am also going to cut the price at which you should cover the Tesla short, another one of our longstanding positions, from $425 to $325.

Adding this week's Saga recommendation, we now have six short and long positions each, which seems right given that markets are trading at relatively high valuations.

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