FirstGroup‘s (LSE: FGP) shares rose more than 6% to 126.5p by early afternoon trading, following better-than-expected full year results. Adjusted earnings per share (EPS) rose 30.7% to 9.8 pence, beating analysts expectations of 9.2 pence.
Margin improvements more than offsets lower revenues
Revenues did fall significantly though, down 9.9% to £6.05 million, as the subsidy for the ScotRail franchise was reduced. But this did not affect operating profits, as the reduction in the subsidy was matched by a reduction in track access charges.
Demand for Greyhound did fall though, because lower fuel prices. Nevertheless, strong margin improvement, particularly with its US school bus service and like-for-like volume and revenue growth, had more than offset the impact of lower revenues.
Loss of rail franchises
The strong full year results suggest that FirstGroup’s is well on the way to its recovery. Looking forward, the failure to renew its ScotRail and Capital Connect rail franchises will mean its UK rail operations will continue to act as a drag on its earnings and put pressure on cash flows.
In the longer term, a more discipline approach to bidding for new contracts and further efficiency savings will lead to further improvement in operating margins. The results are already visible with the turnaround of itts US school bus business, which has so far completed negotiations for just over half of its contracts.
Discount to peers
Shares in FirstGroup have rallied by 20% since the start of the year, but it continues to trade at a discount to its peers on a forward earnings basis. FirstGroup trades at a forward P/E of 11.9, based on expectations of adjusted EPS of 9.6 pence. But, upward revisions in analysts expectations are likely, following the progress made with price increases and faster than expected passenger numbers.
Stagecoach (LSE: SGC) and National Express (LSE: NEX), two of its larger peers, trade at forward P/Es of 13.6 and 13.9, respectively. Their prospective dividend yields are 2.6% and 3.4%, respectively. Although FirstGroup had cancelled its dividends since 2013; it could resume dividend payments soon as its cash flow situation is likely to improve after its two rail franchises expire.
Unlike FirstGroup, Stagecoach is doing much better with its rail franchises and doing relatively poorly with its bus business. Having won the East Coast Mainline franchise at the end of 2014, rail revenues are set to climb to over 50% of the group’s revenues. Margins for UK bus routes have recently been declining though, because of higher staff and pension costs and a price war with Manchester bus services.
The long term outlook for Stagecoach remains attractive, because increased traffic congestion will likely increase demand for bus travel, even if fuel prices remain low. But, margin compression in the medium term is likely to hurt earnings growth.
National Express is most attractive on free cash flow generation, with its shares carrying a free cash flow yield of 11.8%. With such strong cash flow generation, the company has so far been rapidly reducing its indebtedness. But, with its net debt to EBITDA, a measure of indebtedness, soon falling to its lower bound target of 2.0x, we could expect more rapid dividend growth within the next few years.
National Express seems to be more attractive than Stagecoach, but FirstGroup appears to have greater upside potential than the two, because of the likelihood of further margin gains and its less expensive valuation.