Will a general recovery help Stagecoach?

A thicket of adjustments, discontinued operations, separately disclosed items and one-off charges made the full-year results for Stagecoach (SGC) almost incomprehensible. On paper, at least, the balance sheet moved back into positive shareholder assets of £61m, though these were effectively comprised of goodwill and intangible assets. The overall impression was that while passenger numbers will surely recover, management admitted it would be “some time before demand for our public transport services returns to pre-Covid levels”. Which is fortunate, in a way, as, judging by the state of the books, management will spend most of the intervening time in a staring contest with its banks.

To further that end, Stagecoach has negotiated covenant waivers on its debt until next year when these will be stress-tested again, in return for maintaining a minimum level of liquidity. A snapshot current ratio of 0.79 indicates that the balance sheet may not have enough current assets to meet its current liabilities, so securing a period of grace was a minimum requirement. Getting the liquidity in place meant halting capital expenditure, cutting the dividend and managing cash flow to generate a £39.5m reduction in headline net debt. Stagecoach also carries a pension liability of £263m.

Meanwhile, although the end of Stagecoach’s train franchises removes one source of continued risk, it leaves the company with a long tail of liabilities and contractual obligations in relation to the defunct franchises. These have a carrying value of £88.4m, which if settled tomorrow would increase consolidated net debt by the same amount, bringing it up to £401m. The pandemic did have some financial benefit for the company in that its radically reduced overall mileage meant a significant gain on its fuel hedges of £4m.

Overall, Stagecoach’s predicament puts it in special situations investment territory, in the sense that the likely drivers of a price recovery are linked more to management’s administrative actions, rather a fundamental pick-up in its markets. While Stagecoach’s high operational gearing will help it to recover, should that recovery come, it is impossible to rule out a major debt restructuring, or a dilutive placing to bring the balance sheet under firm control. Paradoxically, the prospect of either scenario, while disruptive, leaves a medium-term price recovery in play for the very boldest investors. Consensus estimates for adjusted EPS put Stagecoach on a forward rating for FY2022 of 19. Upgrade to hold.

Last IC View: Sell, 82p, 9 Dec 2020