UK rail and bus: All change
Potential positive trigger looks closer the worse the
outlook gets
Railroads
Damian BrewerAC
(44-20) 7325-7310
damian.brewer@jpmorgan.com
Andy Jones
(44-20) 7325-1622
andrew.r.jones@jpmorgan.com
J.P. Morgan Securities Ltd.
Summary Ratings and Estimates
Company Price Rating Price Target PT End Date Metric Current FYE Next FYE
Arriva plc (p) 454 N (p) 603 Feb-10 Adj. EPS (p) 58.23 (p) 54.99
prior OW (p) 609 Jan-10 (p) 55.10
FirstGroup plc (p) 289 OW (p) 392 Feb-10 Adj. EPS (p) 48.02 (p) 44.13
prior N (p) 377 Jan-10 (p) 48.71
Go-Ahead Group plc (p) 953 UW (p) 998 Feb-10 Adj. EPS (p) 139.20 (p) 84.74
prior N (p) 1,128 Dec-09 (p) 143.73 (p) 129.86
National Express Group plc (p) 337 N (p) 380 Feb-10 Adj. EPS (p) 91.49 (p) 68.67
prior OW (p) 692 Jan-10 (p) 73.27
Stagecoach Group plc (p) 130 OW (p) 187 Feb-10 Adj. EPS (p) 21.53 (p) 12.13
prior UW (p) 166 Dec-09 (p) 21.52 (p) 17.33
Source: Company data, Reuters, J.P. Morgan estimates. All prices as at 06 Feb 09.
See page 38 for analyst certification and important disclosures, including non-US analyst disclosures.
J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may
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investment decision.
Upside potential illustration using on a
re-rating to historical PER
Base f/c
upside
Rail
scenario
upside **
Min Div
yld
ARI 38% 46% 6.0%
FGP 77% 101% 7.1%
GOG 12% 57% 5.5%
NEX (*) 127% 169% 0.0%
SGC 27% 84% 5.0%
Source: J.P. Morgan estimates as at COB 06/02/2009.
*We think NEX carries re-financing risks. ** Rail
scenario based on our conjecture that contracts are
moved to a 1% management fee basis
Base case forecast: 09E-10E PER and
av. EPS growth 09E-1E
FirstGroup
Stage'ch
Arriva
Nat' Exp. Go-Ahead
Peer mean
-30.0%
-20.0%
-10.0%
0.0%
10.0%
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
12.0
PER 09E
EPS growth 09E-10E
Source: J.P. Morgan estimates.
• Rail earnings risk is the investor ‘fear factor’ we find – but this
misses the chance to (almost) double value. The UK outlook continues
to deteriorate, and we are cutting estimates to reflect -2.9% 09E GDP
and -1.0% 10E. Our new estimates for 09E are (on av.) 19% below BBG
consensus. Nevertheless, in our recessionary view, we think the sector is
oversold at 8.3x PER (vs 97-07 11.7x). As earnings reach a floor rating,
we see growing chances of a re-rating trigger – from rail. At mid cycle
WaCCs and PERs we think rail/bus share prices might even double.
• National Express faces (growing) debt risks – which once resolved
could give it more geared upside. Short-term, we see a deteriorating
environment increasing risk of losses in rail, which may need to be
resolved before financial structure can change. In the meantime, we see
deteriorating visisbility and higher risk to DPS, EPS and equity value.
• We see rail contract reprofiling as a positive trigger: Pardoxically,
the worse the outlook gets, the more likely it could be: This note looks
at why we think this could occur, what has happened historically, and
which shares could then have the most upside. We think a subsequent
risk/reward reassesment might trigger re-energised investor interest.
• We upgrade FirstGroup and Stagecoach to OW (from N, and UW)
with both carrying 5%+ dividend yields and signifcant base (FirstGroup)
and rail management fee contract scenario value upside – without the
degree of short-term capital structure challenges at NEX.
• Arriva and National Express are reduced to N (both from OW),
which reflects Arriva’s defensive position, and thus lack of as much
upside gearing from rail if the risk/reward changes. Our cut to NEX’s
rating reflects our growing concerns over its financial structure. With
solid management teams, we see absolute upside in both shares, which at
mid-cycle WaCCs and PERs could still almost double in value.
• Go-Ahead to UW (from N). We see upside across all the bus shares, but
our estimates suggest Go-Ahead has relativley less, and hence, we rate it
UW. Nevertheless, our 998p 12-month SoTP-based PT would rise to
1499p (on average 97-07 PER) with rail recast on a 1% management fee.

Table of Contents
We think it is time to re-assess risk/reward ...........................4
Moving to risk: Rail landscape changes become more possible, in our view..............5
Timing: Next 6 months likely to be tough …..............................................................6
… but use this to position (using income yield) for better 12 month returns...............6
Bus: Fuel causes margin lag effect – but it should be temporary.................................7
Rail – UK GDP deterioration is the fear, but we estimate its now more than priced-in
....................................................................................................................................9
Forecast changes for each company – ongoing rail contract exposure ......................11
Rail – what happens next? Re-visiting a post Hatfield 1% ‘management fee’ scenario
..................................................................................................................................12
‘New’ rail scenario: Base case losers might become the upside winners, but pain
before gain possible ...................................................................................................13
Capital Structure and Dividends ................................................................................13
National Express: Rail and financial structure issues to resolve – but it could be
bus/rail sector positive trigger....................................................................................15
Price targets, ratings and action pointers............................16
Valuation metrics under base and 'new' rail scenario.................................................16
Timing – the 6 month trading vs. 12 month rating view............................................16
Action points, new PTs and rating changes ...............................................................17
Follow the leader .......................................................................................................20
Arriva .......................................................................................21
FirstGroup...............................................................................23
Go-Ahead ................................................................................25
National Express ....................................................................27
Stagecoach .............................................................................29
Valuation Methodology and Risks ........................................31

Tables
Table 1: Base case and nil rail EBIT scenarios based PER discount levels (p, x) .......4
Table 2: Rail and Bus sum-of-parts and equity risk premium (ERP) sensitivities.......5
Table 3: UK Local bus - London as % total revenues 09E ..........................................7
Table 4: UK macro-economic outlook.........................................................................9
Table 5: Rail contracts by operator ............................................................................10
Table 6: Rail and bus forecast changes to new base case (UK GDP -2.9% 09E, -0.9%
10E)...........................................................................................................................11
Table 7: UK rail revenues post Hatfield incident by four week rail period ...............12
Table 8: Rail and bus forecast changes vs. new base case on rail moving to 1% (of
ticket sales) management fee from year 2 onwards (£/p)...........................................13
Table 9: Rail and bus company debt structure (£m) ..................................................14
Table 10: Outstanding bonds as disclosed .................................................................14
Table 11: Outstanding loans as disclosed ..................................................................14
Table 12: ND/EBITDA strain under different scenarios............................................14
Table 13: National Express: Equity rights scenario valuations..................................15
Table 14: Bus and rail PERs and rating vs. historical levels......................................16
Table 15: Dividend yield scenarios............................................................................16
Table 16: EPS stabilisation & re-rating prospects .....................................................17
Table 17: Rail and Bus sum-of-parts valuations and equity risk premium (ERP)
sensitivities ................................................................................................................18
Table 18: Rating changes: looking for the rail scenario upside, trying to avoid short
term dividend yield pitfalls ........................................................................................19
Table 19: Arriva - forecast change details .................................................................21
Table 20: FirstGroup forecast change details.............................................................23
Table 21: Go-Ahead forecast change details .............................................................25
Table 22: National Express forecast change details...................................................27
Table 23: Stagecoach forecast change details............................................................29
Figures
Figure 1: Bus and rail PER relative to UK market.......................................................4
Figure 2: Change in Bus EBIT forecasts (% yoy)........................................................8
Figure 3: UK bus – margins on incremental turnover reflect changes in (hedged) fuel
costs) ............................................................................................................................8
Figure 4: Peak morning London mainline rail arrivals (change yoy) ..........................9
Figure 5: Base case and rail management fee scenario valuation upside (Historical
PER based).................................................................................................................17
Figure 6: Arriva share price performance ..................................................................21
Figure 7: Arriva - EBIT mix progression £m.............................................................21
Figure 8: FirstGroup share price performance ...........................................................23
Figure 9: FirstGroup - EBIT mix progression £m......................................................23
Figure 10: Go-Ahead share price performance..........................................................25
Figure 11: Go-Ahead - EBIT mix progression £m ....................................................25
Figure 12: National Express share price performance ...............................................27
Figure 13: National Express - EBIT mix progression £m..........................................27
Figure 14: Stagecoach share price performance ........................................................29
Figure 15: Stagecoach - EBIT progression £m..........................................................29