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AA defends £2.77bn debt pile as it warns on profits and cuts dividend

Ayesha Javed
The AA warned on profits and slashed dividends as it set out plans to improve - Geoff Pugh

The AA has defended its eye-watering debt pile after warning on profits, slashing its dividend and ramping up spending after a difficult period for the breakdown recovery and insurance company, which ousted its former boss Bob Mackenzie last year.

Shares in the AA plunged more than 30pc in morning trading after it said earnings before interest, tax, depreciation and amortisation (ebitda) would be between £335m and £345m in the year to next January, compared with analysts’ estimates of £390m.

Simon Breakwell, the firm's chief executive told The Telegraph: “None of the actions that we announced this morning we took lightly.”

The AA has had a difficult few years, with declining membership numbers and the dispute with Mr Mackenzie, who was sacked after a punch-up with a colleague.

The company’s hefty £2.77bn gross debt pile has also come under scrutiny. 

Martin Clarke, chief financial officer said the AA had “a very long-term sustainable debt structure” and refuted suggestions that such a highly leveraged capital structure did not belong on the public market.

He added: “It is fixed price, there’s no amortisation, the maturities are spread out over the next eight, nine years. The structure itself basically anticipates refinancings and rolling over... It is an evergreen structure.”

AA share price

The AA will need to refinance £500m of its debt before it matures in 2020, with a further £250m coming due by 2021 and £1.27bn in 2022.

Mr Clarke said that the company was “not complacent” about its debt burden. “We want to reduce the debt over time but the important thing is that it doesn’t impose any operational or financial constraint on the business.”

He said that rising free cash flow once the company has gone through its investment phase would create a “natural equity-for-debt swap, so as we generate more cash, it basically accretes the equity value, which at the moment... is a relatively low number”.

The AA said it had “significant headroom” on tests imposed by its creditors, known as financial covenants.

It added that its ebitda would have to fall to about £200m for the company to be close to breaching its default covenants.

The AA plans to use new technology such as connected cars and roll out an extra 65 vans in the hope of turning its fortunes around.

Mr Breakwell said the plans would “take the AA from a company helping when you break down to one actually predicting when you might break down in the first place”, as well as improving its efficiency and resilience and attracting more young customers.

The AA also plans to spend £20m to £25m of its £80m of cash available to invest in its insurance business for the first time.

Mr Breakwell said that the underwriter and broker had consistently been meeting or exceeding targets "but we've been sort of hamstrung in the past because we haven't been willing to take the short-term profit hit, which you have to when you're growing an insurance business."

Former chief executive Bob Mackenzie was ousted last year after a punch-up with a colleague.

He hopes that growing the insurance business will help to boost membership numbers because the company will be targetting non-members for the first time and plans to cross-sell roadside assistance membership to new insurance customers.

The AA boss said: “I think all of the shareholders that we have realise that we’ve got some work to do here at the AA, but they are most interested in a plan that really delivers long-term shareholder value that’s honest about where we are now but actually is realistic about where we can get to.”

To help fund these changes, annual dividends will be slashed to 2p per share, down from 9p in 2017, saving it around £43m. Investors will receive a final dividend of 1.4p for the year to January 2018, taking their total for the year to 5p.

Without committing to a timeframe, Mr Clarke said that the AA “ought” to be returning to a more normalised dividend level in the next three years.

Mr Breakwell added: “These investments, while reducing our short-term profitability, are vital to our long-term success.”