FTSE 350 transport & leisure: Rail takes centre stage

Two independent inquiries launched by Patrick McLoughlin, the new secretary of state for Transport, will make sure of that. The first inquiry made "extremely uncomfortable reading" for top brass and a second by Eurostar chairman Richard Brown has just told ministers how to avoid a repeat.

There will be shorter, potentially less lucrative franchises – between seven and ten years rather than 15 – with an option to extend. Bidders will receive protection from macroeconomic risks like swings in GDP and the London jobs market, and may need to stump up less capital, too. We’ll learn more next month when the Department for Transport publishes plans for the three tenders put on ice – Great Western, Essex Thameside and Thameslink – following West Coast. A new franchising timetable will be published by the end of April.

Predicting the winners is as tricky as ever. Incumbent operators have a clear advantage, yet FirstGroup (FGP) snatched West Coast from Stagecoach's (SGC) Virgin joint venture, albeit briefly. How much was down to incompetent civil servants remains to be seen. For now, share prices factor in little for new rail franchise wins, but the upside could be substantial. Keeping Great Western might be worth an extra 76p a share to FirstGroup, said JPMorgan before the Brown review. It's worth 63p a share for Stagecoach and 71p a share for outsider National Express (NEX). Unfortunately, it could be a year before we find out the winners given impossible timescales mean existing contracts must be extended, just like West Coast.

A decision on debt-laden FirstGroup's dividend will come sooner. Already blackened by a profits warning in March, the West Coast debacle guaranteed that 2012 was a year to forget. Progress turning around the group's bus division has been painfully slow and this year will be difficult, too. Most analysts expect a cut in the full-year payout of at least a third. They fear the same at Go-Ahead (GOG) should it lose Thameslink.

Go-Ahead admits bid assumptions for its Southern franchise were too ambitious and the government will have to cover 80 per cent of the revenue shortfall from September. What's more, Southern becomes part of the new Thameslink franchise, so winning here is vital. It probably will, but if not, an extra £30m of profit from the bus business by 2016 may plug the hole. Watch progress closely.

There are no such worries at National Express. It doesn't need rail earnings to bankroll the dividend. In fact, barring any further collapse in Spain, strong cash generation puts a dividend hike on the cards in 2013. And the odds are pretty good. We exited our sell tip in July as Spain stabilised and revenue grew in both the North American and UK bus operations. The shares are up since and show promise.

The UK's most profitable bus company shows promise, too. We've tipped Stagecoach as a buy for more than a year and were rewarded with double-digit returns in 2012. In fact, it was the only transport group to end the year with its shares in positive territory and is our pick to repeat that feat in 2013. Fare rises have offset higher fuel prices and cuts in government subsidies which took effect in April, while hefty motoring costs and anaemic economic growth should underpin regional bus volumes. Don't worry too much about its New York sightseeing operation, either. Even if monopoly concerns force a break-up, earnings there are reasonably insignificant and Americans still love its Megabus operation.

FAVOURITES:

With profit margins at its core bus business way ahead of the competition, Stagecoach justifies its premium rating and safe-haven status. On the shortlist for Great Western and Thameslink, and a sure bidder for both West and East Coast lines, it's a free bet on rail, too.

OUTSIDERS:

It's taking too long to shape up FirstGroup's weary bus division and a possible fundraising is a threat. That said, hitting self-help targets and rail wins would change our negative view.