All aboard National Express's ESG play

Some think the solution to the carbon transport problem is electric cars for all. However, electric vehicles still need to be manufactured and then powered – often from carbon-intensive grids. In fact, travelling by an internal combustion engine coach produces fewer emissions than using an electric car. National Express (NEX) hopes to a key role in the transition to net zero and has used its recent full-year results to big up its environmental, social, and governance (ESG) credentials.

In those figures, the coach operator cited a report from the UK Climate Change Committee, which expects between 9 and 12 per cent of car journeys to switch to buses by 2030. Strikingly, every 1 per cent shift from cars to buses results in a 23 per cent increase in bus passenger kilometres. If these numbers are accurate, then only 5 per cent of car passengers would have to shift to buses to double the market size for bus travel.

This transition will create tailwinds to National Express’s ‘Evolve’ strategy, the aim of which is to increase revenue by £1bn and operating profit by £100mn by 2027. This would be a 46 per cent increase on the £2.17bn of sales generated in 2021 and looks achievable given the growth of the wider market.

Back on the road

As expected, the pandemic wasn’t very forgiving for a company that relies on strangers sitting next to each other in enclosed spaces. From March 2020, passenger volumes dropped 80 per cent, leading revenue to fall 29 per cent to £1.96bn for the year as a whole. This fed through to a statutory loss before tax of £445mn, against a £187mn profit in 2019.

Losses would have been even greater if it wasn’t for the government furlough scheme. At its peak, 40,000 National Express employees were either temporarily or permanently placed on state support, saving the company £300mn in operating costs.

Operations are now gradually getting back on the road. Although the year was bookended by considerable virus-related disruption, 2021 sales climbed 11 per cent to £2.17bn, while the statutory loss before tax narrowed to £84.9mn. This was driven by improved performance in all geographies.

ALSA – which operates buses in Spain, Portugal and Morocco and makes up 33 per cent of group revenue – saw underlying profit jump from £6.7mn to £56.6mn. On urban routes, passenger numbers returned to 90 per cent of pre-pandemic levels, while long-haul passenger levels were back to 70 per cent before the Omicron variant arrived at the end of the year.

Underlying operating profit at the North American division, which accounts for two-fifths of sales, increased 500 per cent to £47.4mn. Transit bus service volumes returned to 76 per cent of pre-pandemic numbers while the return of in-person teaching boosted activity in the school bus service arm. Wage inflation needs to be kept an eye on. Driver shortages pushed wages up 5.4 per cent in 2021.m Yet this did not stop the underlying operating margin jumping from 1.5 per cent to 8.5 per cent during the year.

The UK was the only region to post in the red. The £23mn underlying operating loss fell short of broker Peel Hunt’s £6mn profit estimate, thanks again to the Omicron sting. Demand had improved to 80 per cent of pre-pandemic levels by November, but the Covid-19 resurgence hit the last two months. Promisingly, management noted a “rapid bounce back in passenger demand" from January, while Peel Hunt expects volumes to "eclipse their recent high in March". 

To manage cash, management cut the dividend in 2020 and 2021. Should revenue return to 2019 levels in 2023, as expected, the plan is to restore shareholder distributions. At what level remains to be seen, however: rising wage inflation means that operating profit margins are forecast to stay around 9 per cent between 2022 and 2027, just below the pre-pandemic level of 10 per cent.

Higher petrol costs, higher coach demand

Investors might expect spiking oil prices and the rising cost of petrol would undermine profit margins alongside wage inflation. However, somewhat counterintuitively, rising fuel prices may prove to be a good thing for profits. For one, National Express has fully hedged this year’s fuel requirements, meaning higher pump prices won’t hurt the cost base until at least 2023.

Instead, higher fuel costs may prompt cost-conscious car drivers to switch to bus or coach travel.

According to Peel Hunt, record fuel prices have “historically increased bus passenger volumes”. As prices at some forecourts hit £2 a litre last week, Conservative MP Robert Halfon made the grim assessment that some of his constituents were “sleeping in car parks overnight” because they could not afford the commute home. While public transport is not available to all, lower-cost alternatives to car travel will look increasingly attractive to many.

In the longer term, policies to foster less carbon-intensive forms of travel are likely to support substitution to shared modes of transport. National Express, which has pledged to stop buying diesel coaches and steadily roll out electric buses and zero-emission vehicles, should benefit.

Next stop: balance sheet repair

Importantly for investors’ long-term prospects, the group made it through the pandemic without crippling the balance sheet. In the two years to December 2021, net debt fell from £1.22bn to £1.02bn, in part thanks to a £235mn equity raise in 2020. Correspondingly, annual net interest payments declined 9.5 per cent to £41.1mn in 2021, equal to 22 per cent of operating cash flow.

Rising interest rates means loan payments will eventually rise. With net debt at 75 per cent of net assets, this might be a concern. However, because the average maturity of National Express’s debt is 4.7 years and 80 per cent of the borrowings are on a fixed rate, finance costs do not pose an immediate threat.

The first refinancing requirements are on a £400mn bond which expires in November 2023. If revenue rises back above pre-pandemic levels by then – and operating cash conversion hits an 80 per cent target – there will be ample cash flow to cover the increased interest payments.

Of greater immediate concern is the fate of a bid for rival Stagecoach, which looks likely to fall through. After tabling an offer worth £470mn, National Express was gazumped by German asset manager DWS, which agreed a deal of £595mn with Stagecoach’s board a couple of weeks ago.

National Express hasn’t given up yet and wants Stagecoach's shareholders to consider its all-share bid because of the “value creation opportunity”. Odds of success are low, given DWS’s premium offer and the fact the original merger was already being investigated on competition concerns.

But if DWS does complete the deal, the positive spin for National Express shareholders is that the asset manager clearly views the sector as undervalued. Its bid, at a 33 per cent premium to Stagecoach’s market value, was priced at just under 10 times consensus earnings forecasts for 2023. National Express, by contrast, trades at a multiple of 8.3.

Given its ESG credentials, recovery story and growth prospects, that looks cheap.