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A low fare is on offer at FirstGroup

The bus and rail group's shares have been maligned in the past year but the valuation suggests now could be a good entry point given the progress in its turnaround plan.
March 31, 2016

Shareholders riding the fortunes of bus and rail services operator FirstGroup (FGP) have travelled about as far in the past year as a seriously-delayed commuter train. Nor have recent trading updates added much optimism. The loss of FirstGroup's franchises to operate the Scotrail and First Capital Connect rail services in 2015 and fewer school days for its First Student bus operations in the US this financial year have taken their toll. But, on the logic that all the bad news is in the share price, this may be a good time for brave investors to buy.

IC TIP: Buy at 94p
Tip style
Speculative
Risk rating
High
Timescale
Long Term
Bull points
  • Shortlisted for South Western franchise
  • Turnaround plan progressing
  • Bonds could be refinanced
  • Valuation cheap compared with peers
Bear points
  • High debt
  • Low oil price given US exposure

Within FirstGroup's rail business - its second-largest revenue stream - the two franchise losses mean turnover from the division will be much lower than in previous years. Against that, the company has secured the TransPennine Express franchise for another seven years - this time as the sole operator - and has been shortlisted for the South Western franchise against the incumbent operator, Stagecoach (SGC). Meanwhile, its Great Western franchise - the UK's seventh biggest out of 19 - doesn't end until 2019. And actuarial tweaks to the First Rail pension scheme should boost trading profit by £15m in the financial year just ended. Better still, passenger numbers rose 3.5 per cent on a like-for-like basis, according to November's half-year results, so there is growth.

Management is several years into its turnaround programme now and Gerald Khoo, an analyst at broker Liberum, reckons some of the most recent issues have "conspired to mask the progress to date". That said, he also thinks management's actions should have more impact on margins and operating profit in the current financial year, which indicates that now could be a good time to buy the shares before the market catches on.

 

Operating profits on the rise at FirstGroup

 

Key aims of the turnaround plan were to improve pricing, productivity and capital allocation, particularly in the First Student US school bus business and UK bus division. Almost three years after the rights issue that rescued FirstGroup's finances, there are signs of progress. FirstGroup's 'up or out' stance to pricing of US school bus contracts has been successful. Liberum's Mr Khoo says contract attrition has been lower than expected and that profit margins have improved.

FIRSTGROUP (FGP)
ORD PRICE:94pMARKET VALUE:£1.13bn
TOUCH:93.9-94p12-MONTH HIGH:130pLOW: 80p
FORWARD DIVIDEND YIELD:nilFORWARD PE RATIO:7
NET ASSET VALUE:118p*NET DEBT:110%

Year to 31 MarTurnover (£bn)Pre-tax profit (£m)Earnings per share (p)Dividend per share (p)
20136.909111.06.2
20146.721127.5nil
20156.051649.8nil
2016†5.7917810.5nil
2017†5.8023113.6nil
% changenil+30+30-

Normal market size: 20,000

Matched bargain trading

Beta: 0.6

*Includes intangible assets of £1.78bn, or 148p a share † Liberum forecasts

The UK bus business, which has been shrunk in recent years after poorly-performing units including London were sold off, has seen investment in a new fleet. That has led to rising passenger volumes and revenues, meaning profit margins have also recovered.

 

 

That said, FirstGroup remains fairly deep in debt - at the end of the first half net borrowings were 110 per cent of shareholders' funds, although management says the seasonality of its First Student business combined with the phasing of cash flows typically means net debt is higher at the end of the first half than the full year. There is, however, a potential positive here. Analysts at JPMorgan Cazenove suggest the gap between bond yields - weighted average of 3.2 per cent - and the weighted average cost of FirstGroup's debt - 7.1 per cent - suggests there is a "significant opportunity" to refinance its borrowings. True, the broker acknowledges this could "take time to materialise", but nevertheless views it as a distinct possibility.

Cheaper fuel is also a slight negative for the company given its high exposure to the US. Unlike in the UK, where lower fuel prices might encourage greater use of public transport, Americans rev up the love affair with their cars when 'gas' prices drop. But management has made attempts to deal with this. Last year it launched a yield-management system for its Greyhound bus business, meaning it can fine-tune prices of its journeys to encourage demand. Furthermore, its First Transit business, which offers commercial transport contracts, has been able to offset the impact of reduced Canadian oil sands activity by winning new contracts.