Stockwatch: A big dividend and solid credentials

Is the market jaundiced towards this mid-cap rail and bus share Go-Ahead due to chronic strikes taking attention off underlying financial strength?

Its chart shows a couple of big steps down in market price during the last year or so, from over 2,600p to below 1,800p in the first half of 2016, amid strike action, although there has been no financial-specific news to trigger.

Indeed, the group achieved a respectable outcome for the financial year to 2 July. Having recovered above 2,300p by early 2017, the price then dropped in response to end-February interims' guiding profits lower than were expected for the full year to 2 July. That's due to losses at the Govia Thameslink Railway (GTR) and a 0.7% slip in passenger numbers in regional bus operations despite 0.8% revenue growth, plus operating profit up 8.6% at London Bus.

What has effectively happened is a status change with capital growth investors being shaken out and replaced with income-seekers; although at about 1,800p currently it's possible to consider buying for share recovery equally because the price can rise if the yield is seen as generous considering overall risks.

Directors buying

During March to early April, the chief executive and finance director, also a non-executive director, made purchases of about £50,000 each, at prices mainly near 1,700p, helping to provide a sense for value, the highest "buy" being just over 2,000p.

This had helped the stock up to about 1,840p, easing a tad after a latest pre-close update has affirmed overall expectations for the current year to 2 July despite a mixed story.

In buses, revenue and passenger journeys are effectively flat in regional and London operations, while rail is mixed with about 4% passenger revenue growth in Southeastern and London Midland offset similarly by a fall on Govia Thameslink Railway.

While there have been no significant strikes on Southern services in the last five months, the ASLEF union is now calling for an overtime ban said by management to "result in unnecessary disruption for customers." GTR says it is fully committed to resolving these issues to reduce uncertainty.

More positively, stable bus revenues/profits support dividend growth (the interim dividend rose 6.5% to 30.17p) and a debt refinancing is underway, which will reduce finance costs in 2017/18. The interim results to end-December 2016 showed net finance costs clipping 7.8% of operating profit and in a low-growth context such efficiency helps grind profits higher.

Risk/reward profile tilts positively

If ASLEF is intent on causing disruption then this won't help perception, but the strength and security of dividends establish a prop, despite net tangible assets per share of only 293p.

See from the table how Go-Ahead's cash flow profile is very robust, significantly ahead of earnings per share (EPS) and with capital expenditure often absorbing less than half of cash flow, thus leaving ample scope for payouts.

A slowing UK economy with pressure on consumer spending would affect some travel – e.g. costlier/longer rail travel for leisure than what's needed for work, although buses will likely enjoy support as an "essential service".

The balance sheet is cash positive: at end-2016 there was £396 million debt and £27.3 million net pension liabilities versus £624.7 million cash, with total dividend payments in the last financial year (to others beyond plc shareholders) of £57.2 million.

So, it would take a profits dent lasting a few years to disrupt payouts over 100p per share as forecast, representing a 5.5%-plus yield. Such are crux reasons why the directors see value around current market prices.

Mind that a 13-month financial year enhances EPS growth of 29.3% projected, which growth is then expected to substantially ease, yet note how a price/earnings PE multiple around 8 times at the current price of 1,830p is half the annual average historic rating for 2015.

Stock is down over £362m; strike costs £15m

This is from the 2016 peak of 2,673p to the current market price; a substantial drop. Yet the outlook statement in the end-February interims cited a cost for the dispute over working practices (driver-only trains) as £15 million for the full financial year.

Obviously, it's possible that issues drag on; some would say privatised rail is targeted for chronic disruption by the Hard Left who will see Jeremy Corbyn's surge in popularity as vindication. But when you compare how the market has effectively valued this risk, with its financial reality to date, the market has over-reacted.

While I believe the drop relates largely to a status change with transport stocks increasingly seen as income plays, it's relevant to compare the annual cost of rail strikes.

Balanced financial profile of bus/rail services

At first sight, deriving 74% of group revenue from rail is quite worrying lest the UK economy slips and rail travel proves more sensitive to falls in disposable income than bus travel. Yet, around 78% of Go-Ahead's profit is derived from bus travel which ought to be a defensive investment. The latest update is mixed albeit firm.

Regarding regional bus operations, which contributed 41% of 2016 operating profit: "Strong growth in passenger journeys in some regions has been offset by softer performance in other operating areas", hence a flat total of passenger journeys with revenue up just 1%. London bus, 36% of last year's profit, has seen 1% revenue growth this year. So, it's effectively flat albeit sound in terms of cash generation, which is what counts now a yield valuation is in focus.

Go-Ahead also has a bus operation in Singapore and has a rail contract in Germany – to start from end-2019 – "a valuable addition to our growing portfolio of German rail businesses". Besides working on a new bus contract coming up for tender in Singapore, "we are considering a number of opportunities in international markets," which should help mitigate the risk of a principal exposure to the UK.

Economic slowdown is therefore likely the chief risk, with union disruption an ongoing irritant, yet Go-Ahead's strong yield credentials and the directors' buying imply investment value.

The stock's easing to about 1,840p to 1,800p on the Thursday afternoon post the update shows prices can still vary according to concerns that the story lacks vigour. But the chart context suggests these drops are being used by income seekers to accumulate.

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.