GO Ahead Group (The) (GOG)


Stockwatch: Yield and cash protect this train wreck

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Stockwatch: Yield cash protects train wreck stock pick Southern Rail GTR strikes
Does a privatised essential service industry have shareholder value underwritten during a majority Conservative government? It's a cynical hunch, albeit relevant beyond the 1980s privatisation programme, which sold off state assets cheaply then extended into transport during the 1990s, with various listed stocks originating from bus and rail sell-offs.

Currently in the news is what amounts to a shareholder subsidy, by way of the transport secretary giving Network Rail £20 million to fix infrastructure problems affecting Southern Railway. Southern is part of the Govia Thameslink Railway (GTR) franchise 65% owned by the Mid 250-listed Go-Ahead Group (GOG).

The state funding comes despite the company declaring strong prelims a day later, with buses making an adjusted operating profit up 8.0% to £100.4 million and rail by 36.7% to £57.0 million as other rail franchises do well.

Any ordinary business would have to invest out of cash flow or raising debt/equity, but with transport politically sensitive, the Conservatives appear determined to ensure the "private" model succeeds, to fend off Labour claims that key services should return to public ownership.

Effectively, government is mitigating the aspect of exceptional charges, hence improving confidence in financial growth.

Will more such examples arise now Jeremy Corbyn looks set to remain Labour leader - albeit with low credibility in a general election, hence the prospect of a lengthy period with the Conservatives in majority government?

5% yield a support

Media coverage of the Southern Rail disruption exacerbated a summertime fall in Go-Ahead shares from about 2,500p to below 1,800p. It created a sense that the costs and investment needed for the rail side could temper group earnings and dividends, such that pricing in a 5%+ yield was appropriate for the risk.

Even conservatively, earnings cover for the dividend is around two timesNews of the £20 million of infrastructure money was followed by strong prelims, which reminded investors that the Southern train problems are quite a side-show.

Mind that: "in arriving at operating profit numbers for rail, management has made judgements as to the outcome of discussions with Network Rail and the government as to where financial responsibility lies for train cancellations and delays".

Yet the overall story reads plenty better than the coverage of commuter woes on Southern had led investors to believe. Go-Ahead enjoys strong market positions: it's the largest bus operator in London, with a 24% market share, and trading in the Southeastern and London Midland rail franchises remains robust, offsetting difficulties at GTR.

What constitutes "normalised" earnings per share can be subjective, highlighted by the company proclaiming 181.8p for financial year 2015 and 220.5p this latest year, while Company REFS (see table below) cites 174p and 168p respectively.

The stock has jumped from £19.80 to over £22, trying to find an equilibriumBut even on a more conservative view, the earnings cover for the dividend is around two times, and this is even better in terms of cash flow as structural changes in rail franchises helped cash generation jump 45.6% to £212.4 million versus total dividend payments in the last financial year (also to non-controlling interests) of £57.2 million.

A re-rating is therefore justified with financial cover for the dividend looking more secure; the stock has jumped from about £19.80 over 2,200p, now 2,170p as price tries to find a short-term equilibrium. Don't be put off by this heavy price, which follows from just 43 million shares issued; the value drivers are all, and appear net positive.

Looking beyond bad news

There is a risk that staff absence and strikes drag on - another is scheduled this week over the phasing out of train guards. Yet Go-Ahead's chairman declares that the group outlook and opportunities are positive, with the new financial year maintaining recently positive trends.

Continued growth is expected from buses thanks to lower fuel costsHis chief executive characterises the GTR investment programme as "a once in a generation opportunity to respond to 40% passenger growth on Southern in the past few years".

Customers will see gradual improvements over the next two years but network capacity will remain restricted until end-2018 when the chief benefits will arise. With the government stepping in both financially and by creating a new "project board" to accelerate improvements, the issues at GTR look more surmountable than a black hole.

Continued growth is expected from buses as lower fuel costs offset contract reductions from local authorities: £72 million has been spent on over 300 new buses and £13 million on new depots.

Relative to discretionary consumer spending, essential service revenues like this should be resilient, also with some freedom to price considering Go-Ahead’s strong market positions. UK recessionary fears likely contributed to the summer stock plunge, but a recent rebound in purchasing managers' indices (PMIs) are scotching them.

GOG has two contracts for the German rail market, which has annual revenues of about £8 billionAll this aids confidence in forecasts and in terms of overall risk/reward for the business it's worth recalling a French takeover bid in 2000. Even though it failed at the time and would likely run into political controversy if repeated, the current period is financially opportune to do so.

Initiatives abroad also enhance longer-term upside: a five-year contract has been signed in Singapore for 25-route bus service, modelled on London. Two contracts have also been achieved for the German rail market, which has annual revenues of about £8 billion equivalent.

Buying the drops

Coming early in the May administration, this £20 million "bonus" makes you wonder if it exemplifies a centrist-styled Conservative government ready to assert a new form of industrial policy - if so, who else could benefit?

It's akin to the "Bernanke put" whereby Central Banks have underwritten stock values with monetary stimulus, making "buy the dips" a compelling strategy. The authorities talk "virtues of private enterprise" but maintain interventions of sorts - here, amounting to state aid for a private firm.

The plunge on Go-Ahead's five-year chart is justifiably being bought, with recovery scope to 2,500p and better according to the chart and fundamentals.

For more information see the website.

Go-Ahead Group- financial summary Consensus estimates
year ended 2 July 2012 2013 2014 2015 2016 2017 2018
Turnover (£ million) 2,424 2,572 2,702 3,215 3,361    
IFRS3 pre-tax profit (£m) 84.5 63.1 91.2 78.7 99.8    
Normalised pre-tax profit (£m) 86.5 66.5 88.7 103   135 146
Operating margin (%) 4.3 3.2 3.5 3.3      
IFRS3 earnings/share (p) 129 107 162 120 161    
Normalised earnings/share (p) 125 110 141 174 168 206 222
Earnings per share growth (%) -12.3 -12.3 28.6 23.8 -3.9 22.6 7.8
Price/earnings multiple (x)         13.2 11.6 10.1
Cash flow/share (p) 320 229 366 925      
Capex/share (p) 188 133 157 112      
Dividends per share (p) 81.0 81.0 81.0 85.6 91.7 99.0 104
Yield (%)         4.2 4.5 4.7
Covered by earnings (x) 1.6 1.4 1.8 2.1 1.8 1.9 2.1
Net tangible assets per share (p) -161 -128 -86.2 -45.1      
Source: Company REFS

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.