Goldman Sachs backs FirstGroup to rocket

Humming along in the slow lane, FirstGroup's turnaround has so far lacked inspiration and the share price has plummeted. But after a bounce following the market crash in February, the bus and train operator has caught the eye of Goldman Sachs, which thinks the transformation is about to kick up a gear.

A restarted dividend could even generate a yield of 5%, according to Goldman, which keeps FirstGroup on its Conviction List, with price target increased thruppence to 163p, implying 61% upside.

Prioritising margin recovery in UK bus and First Student should underpin powerful double-digit earnings growth from 2016-2019, with a compound annual growth rate (CAGR) of 10%, Goldman says. At 101p, the shares trade on just 8 times 2017 earnings estimates, which does appear modest given forecast earnings growth.

The value of the struggling business has collapsed 88% from its 2007 peak, losing nearly three-quarters of its value since 2013 alone, when the company suffered a sharp fall in profits and launched a £585 million rights issue to bankroll its turnaround.

At the time, FirstGroup said it wanted to achieve an investment grade rating in the medium term, with a leverage of 2-2.2 times net debt/cash profit. Goldman reckons this will be achieved in 2017, pencilling in a decline to 1.8 times a year later.

Recently falling out of its bullish trading channel, the shares called on technical support at 94p earlier this month. Previous support at the lower trendline now acts as resistance.

Goldman blames the "slow" turnaround on negative trends in the UK bus industry, on the high street and oil prices. It has been a complex turnaround, too.

"While we see progress to date as relatively slow (partly influenced by weakening industry trends, especially in UK bus), we stay confident the plan is on track and expect FY 2017 to be an inflection year in free cash flow generation (£100 million)," says analyst Alexia Dogani.

Granted, a target price with 61% upside is ambitious, look out for weak demand, volatile fuel prices and mispriced franchise awards. But there are a number of potential catalysts that could make it a reality.

Initially, stabilising like-for-like revenue from its US and Canadian Greyhound coaches will help underpin margin recovery to an ambitious 12%. Throw in a tasty dividend to reflect cash flow forecasts and a couple of rail franchise wins - a decision on the East Anglia is imminent and South West should be announced in February - gets you to Goldman's 163p target.

It's a risky bet, but this turnaround could be about to swing into the fast lane.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser