An austerity drive for public transport

Subsidies to private companies such as Stagecoach and National Express will not be among the easiest targets for the October spending review, though. Buses tend to be used by the less well-off and elderly, so scaling back services would be seized upon by the opposition as proof that the Conservative-Liberal coalition is not as "progressive" as it claims. Moreover, although bus subsidies have risen by an astonishing 127 per cent in real terms since 1999, at £2.9bn they remain low compared with other forms of public transport. Rail receives about £4.6bn a year, which is up £2bn since privatisation.

But nor are trains exactly low-hanging fruit for the austerity-crazed coalition. Their mass appeal makes cuts a huge electoral risk, particularly as the fast-rising passenger numbers and satisfaction levels before the recession mean they are widely considered as one of the last decade's transport success stories. The coalition has also pinned its green credentials on the creation of a national high speed rail network, although it admits in the post-election pact that "given financial constraints, we will have to achieve this in phases".

Yet the absence of obvious victims makes cuts no less necessary. The DfT commissioned a review last December from Sir Roy McNulty, a former head of the Civil Aviation Authority, which has found that the UK railways are much more expensive than their European peers. Mr McNulty is due to report to the new government by October on how to find "value for money".

Derailed

But Network Rail, which owns and runs infrastructure, such as tracks and stations, is likely to bear the brunt of retrenchment. Indeed, train operators only receive £600m net from the government, compared with £4bn for Network Rail. The government has also signalled it may allow ticket prices to rise to plug the gap. In fact, the train companies are so frustrated with the existing franchise system that they view the change of regime - and the transport minister - with guarded optimism.

"The recent history of the franchise model has been that it has become increasingly contractual and increasingly prescriptive," says Nick Swift, finance director of the Go-Ahead Group, which runs the Southern, Southeastern and London Midland networks. He praises the more "commercial" approach of the new government. "The people we are dealing with are like-minded business people. It is early days, but so far so good."

The coalition agreement pledges "longer rail franchises in order to give operators the incentive to invest in the improvements passengers want". The Association of Train Operation Companies (Atoc) has also called for greater flexibility. Indeed, the DfT currently micro-manages timetables, rolling stock orders and even the number of ticket machines.

The difficulty will be reconciling this greater freedom with greater financial stability, which the train operators also want after the National Express fiasco on the East Coast line last year. The East Coast debacle also highlighted for investors an unexpectedly high level of economic sensitivity in the sector. This contradiction may end the industry's honeymoon period with the coalition when the new franchise model is unveiled this autumn, though the impact of any changes will take years to be felt as existing contracts run their course.

Punctured

Cuts to bus subsidies are a nearer-term concern. Bus operators receive money from the government in two ways. First, the DfT gives them a fuel duty rebate called the 'bus service operators grant' (Bsog); second, local councils pay them for concessionary fares - notably the free bus pass for over 60s. This popular Labour policy was actually ring-fenced in the coalition agreement, so that 's likely to stay. The £436m Bsog, which only bus nerds have heard of, looks more vulnerable.

The bus companies are open in warning that any reduction in the subsidy would only mean fares would rise and services be reduced. Brian Souter, co-founder of Stagecoach and a grandee of the bus industry, confidently predicted at the company's annual results in late June that the government would not risk the grey vote. But analysts are less confident. "Bsog is unlikely to be removed in its entirety, but the government might chose to freeze it or reduce it over time," warns Gert Zonneveld at Panmure Gordon.

The company most exposed to these cuts is Stagecoach, which makes 71 per cent of its operating profits from running UK buses at an industry-leading margin of 14.4 per cent. The government might find that a bit fat for leaner times. Go-Ahead is the next most exposed, with 63 per cent of profits from UK bus, followed by FirstGroup and National Express, both with under 30 per cent. Arriva, which is in the process of being acquired by Deutsche Bahn, has fallen out of our investment universe.