Bus and Rail
Ring-fencing Rail;
Bus Offers Fuel for Thought
Focus in Rail back to volumes and fares. National
Express, which we wrote in May was the only company
with good reason to hand back a rail franchise, has since
done so. It seems unlikely any other operator will do the
same at present. We therefore expect investor focus to
turn back to passenger volumes and fare increases. We
see no need to make major changes to our existing
forecasts. If anything, -4% for pax vols in 2009/10 looks
severe vs recent signs of stabilization at -1%, though we
do expect a further deterioration in UK employment. For
2010/11, we expect limited yield improvement due to
regulated fare decreases, based on July 09 deflation of c.
-1.8%.
Rail remains a drag; risk of undervaluing Bus.
Recently won rail contracts will continue to cause a drag
on group profitability. As these are finite, applying
multiples to group earnings depressed by near-term rail
losses risks undervaluing the perpetuity bus businesses.
We therefore calculate a ring-fenced value for Rail,
using an NPV for existing contracts, and add it to our
valuation of the bus businesses. A word of caution:
even when rail pax revs and vols start to recover,
2011/12 in our forecasts, operators will not benefit from
high operational leverage as they have previously, due
to revenue share & protection mechanisms, meaning it
is dangerous to look at historical share price charts.
2009/10 is the trough year for Bus: time to buy. Bus
operators are being hit hard this year by higher than
normal fuel costs, due to hedges locked in at $90 to
$100/bbl, and some price elasticity of demand due to a
deflationary environment; yet operating profits are only
set to be down around 10% on average, underlining the
defensive nature of these businesses. These two
factors become a lot easier next year, and from 2011/12
we expect a return to structural growth in the UK.
FirstGroup best positioned in context of the above.
We upgrade FGP to OW. See our separate note out
today entitled: “Next two years should be focus for First”.