Join our community of smart investors

FTSE 350: Mind the gap before you hop aboard transport stocks

The services this sector offers to its customers are virtually identical but where it operates can be a key differentiator.
January 29, 2016

Buses and trains might all look the same to you but the fortunes of this tight-knit sector couldn't be more polarised.

Important drivers of performance for FirstGroup (FGP), Go-Ahead (GOG), National Express (NEX) and Stagecoach (SGC) are the composition of their bus businesses and the size of the rail franchises they hold.

With buses, having a greater regional presence can be a positive thing as margins on services outside London are higher than inside the capital. This is because the system outside London is deregulated, meaning operators can choose the routes - and the price for travelling on them - entirely independently. But there is a threat to all bus groups in relation to this part of their business. It might be moving more slowly than gridlock at rush hour, but it is coming nonetheless. The Buses Bill paves the way for local authorities to re-regulate buses in their jurisdiction, which could hit margins as local authorities may seek a piece of the pie or insist on less profitable routes.

In the capital, Transport for London collects all ticket fares and then distributes a per mile rate to the bus groups. This is lower-margin income, but provides a little more visibility than operations in the regions. Use of buses in London is also less volatile than throughout the rest of the country.

Another important aspect is the amount of overseas exposure the groups have. Frustratingly for those with US exposure, the low oil price encourages Americans to hop into their cars, even if public transport prices fall in step with the commodity. A strong dollar counteracts to some extent, though, as any earnings made across the pond translate nicely back into pounds.

Rail franchises are also extremely important. FirstGroup is arguably under the brightest spotlight here as it has the shortest-dated franchise portfolio of the peer group. It won the TransPennine franchise in December 2015, but this is one of the UK's smallest franchises by passenger journeys. It would help if it won another of the bids it is competing for.

 Price (p) Market cap (£m)PE (x)DY (%)1-year change (%)Last IC view:
FIRST GROUP            99                    1,195 10.80.0-3.6Hold, 101p, 13 November 2015
GO-AHEAD GROUP       2,515                    1,082 16.73.63.6Buy, 2,338p, 04 September 2015
NATIONAL EXPRESS          302                    1,543 14.23.515.8Buy, 301p, 30 July 2015
STAGECOACH GROUP          270                    1,550 9.64.0-23.3Sell, 307p, 09 December 2015
 

Favourites

We're bullish on National Express thanks to its attractive 13 times forward earnings valuation and 3.5 per cent yield, and Go-Ahead, which has won the Thameslink franchise (which it operates in a joint venture with Veolia under the Govia name) and has successfully entered the German rail market in recent months. The Thameslink win has brought with it higher-than-expected costs, though, so we'll be watching this closely.

Outsiders

Our sell tip on Stagecoach (sell, 352p, 3 December 2015) was well timed as the stock fell 14 per cent on subsequent results. The cause of the drastic fall was a "modest revision" to its full-year expectations. Margins fell in three of its bus divisions, it lost the TransPennine bid and pulled out of the East Anglia tender after disagreements with partner Abellio. Even though the shares are now at 275p, we're sticking with our bearish view.