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FTSE 350: Catching the right transport is a tricky task

Train tickets might be inflation-proof, but trading is tough for UK bus businesses
January 26, 2017

If annual fare increases are a barometer, investors looking for inflation-proof stocks might think they could do worse than a company that runs trains. Average fares in the UK rose by 2.3 per cent at the start of January as the burden of paying for the rail network continues to shift onto passengers. The bill used to be split equally between the government and users, but the latter now pay around 70 per cent of the cost.

But while rising prices, which ticket buyers often can’t escape, might be good from an investment perspective, there is still a decent slug of political risk attached to some travel stocks in the new year. Most notable among these is Go-Ahead (GOG), whose Govia joint venture has suffered ongoing strikes by Southern rail workers. There’s the potential for more strikes and the financial drag that they could bring. Additional investment in the franchise by the company has already meant expected margins for the life of the Govia contract have been cut in half.

This is perhaps why National Express (NEX) decided this month to cut ties with the UK rail industry and sell its only remaining franchise, c2c, to Italian state-owned operator Trenitalia. The group said it would look overseas instead. Stagecoach (SGC) has two franchises likely to generate newsflow this year. It is bidding to retain the South Western franchise it has run for the past 20 years and the new East Midlands franchise starts in March 2018, meaning the government is likely to announce who will have control of that this year, too. It will be important to watch what terms are agreed. First Group (FGP) said in its recent half-year results that its rail division’s adjusted operating profit margins had been rebased closer to 3 per cent from 5-6 per cent due to new operating terms.

Government also wants to change the way rail companies and infrastructure owner Network Rail work with one another. Details – and importantly costs – aren’t even sketchy yet, but some industry stalwarts have been calling for this for years, suggesting it could be a positive for services and customer satisfaction. Some clarity could emerge on this in 2017.

Price (p) Market value (£m)PE (x)Yield (%)1-year change (%)Last IC view
First Group1041,2499.90.05.2Buy, 112.5p, 15 Nov 2016
Go-Ahead2,22095510.14.3-11.8Buy, 2,009p, 14 Oct 2016
National Express3441,759143.415.9Buy, 347p, 12 Jan 2017
Stagecoach2141,2288.75.5-19.3Sell, 209p, 7 Dec 2016

Favourites: Overseas growth and its dominance in the UK coach sector make us bullish on National Express. We also like First Group’s US bias. If problems persist with Govia we may need to revisit our backing of Go-Ahead. The company is expanding overseas, and has taken on a bus contract in Singapore and a rail one in Germany.

Outsiders: We’ve been bearish on Stagecoach and this has been the right call. Its largest bus division is its UK regional operation, which is finding trading tough in rural areas of England and parts of Scotland. It also has a lower percentage of overseas revenue than most of its rivals and must hold on to the two franchises it is bidding for this year.