The way FirstGroup (FGP) presents both its adjusted profits and cash flow performance frustrates me. Its income statement is often littered with exceptional one-off costs which make it difficult to work out its true level of profitability.
I’ve written a lot about FirstGroup (FGP) in my magazine column this week when discussing how to work out a company’s true underlying profits. The conclusions are not particularly flattering for the company.
In many ways, this company should be doing a lot better than it is, as it has some reasonable assets in its UK and US bus companies. It has problems with its long-distance bus services in the US and its rail operations in the UK. It also has lots of debt.
My frustration with FirstGroup is concerned with the presentation of its adjusted profits and its cash flow performance. Its income statement is often littered with exceptional one-off costs which make it difficult to work out its true level of profitability.
This week’s half year results were no different. The Student and Transit business in the US saw a good increase in profits but this was largely offset by lower profits at Greyhound. The UK bus business performed well with a good increase in profits.
Overall, adjusted operating profits increased slightly from £89.4m to £92.4m. But those profits were presented after significant adjusting items. Another big restructuring expense is not a good sign of health and is an outflow of value whether it is exceptional or not. The £17.6m of intangible asset amortisation includes £8.6m relating to software, which is a real cost in my opinion.
Where I have real concerns about FirstGroup is the size of provisions on its balance sheet and their scope to muddy the waters in terms of its underlying profitability.
The company continues to spend more cash (utilising the provision) on self insurance provisions on its US buses than it charges as an expense to the income statement. This may be down to timing and fleet issues and not relate to any wrongdoing, but the fact that the claims are big and estimated means there are grounds to scrutinise the expenses.
The other provision issue relates to the company’s Trans Pennine Express (TPE) rail franchise. Last year, the company made a provision of £106.3m for the expected losses for the remainder of the franchise until 2023. This was treated as an exceptional item in the accounts with all the expected losses being realised upfront in full. This means the losses will be excluded from underlying results in future years.
For the first six months of 2018/19, the company’s underlying rail profits fell from £31.1m to £29.3m but do not include any losses from TPE. Looking at the provision note, the losses look like they were £20.7m which utilised some of the provision.
Because the losses have been realised upfront as an exceptional item, analysts and investors are being told to ignore them. This is all above board as far as accounting is concerned, but I can’t help thinking that FirstGroup’s rail profits were £20.7m lower, at £8.6m rather than £29.3m. In my view, the provision therefore distorts the picture of underlying profitability, but many investors will have ignored this.
I think FirstGroup’s true profits are probably lower than they are currently presented and that debt levels are far too high. I therefore struggle to find the shares attractive despite the very low one year forecast rolling PE of 6.6 times, at a share price of 86.5p. If I was going to invest money in this challenging sector, I would be looking at National Express (NEX), which is by far the best managed business with the best assets in my opinion.
In the rest of my weekly Alpha update, I also look at the effect capitalising and amortising R&D expenses has on Avon Rubber’s earnings. Another theme this week is value traps – and I’ve highlighted some issues for concern with Vodafone and utility company SSE. Finally, I explain why funeral company Dignity is a riskier business than I used to think. Alpha subscribers can read my analysis here.
