Commuters are notoriously wedded to their cars. But even the most ardent automobile lover has a breaking point. In 2008, when oil prices hit $145 per barrel, many decided to ditch their motors. It seems to be happening again. In January US petrol consumption fell 1.3%. In a recent survey of 2,000 Britons, 51% said they were seriously considering switching to public transport for getting to work and 27% warned they would ditch their car if petrol reached £1.50 a litre. So, if history is about to repeat itself, the recent 10% fall in FirstGroup shares looks like a buying opportunity.
FirstGroup is the world’s leading transport operator, carrying some 2.5 billion passengers a year, both in Britain (57% of EBITA) and North America (43%). In the US it owns the Greyhound intercity coaches, the iconic yellow school buses, and manages transport systems on behalf of metropolitan transit authorities. In Britain it runs local bus services, where it enjoys a roughly 20% market share, along with four rail franchises – Great Western, ScotRail, TransPennine Express and Capital Connect.
The reason for the reversal in the shares’ fortunes, though, is that crude has not only temporarily compressed margins, but has also punctured performance at its yellow buses unit. Here results are disappointing due to budgetary pressures forcing schools to consolidate and even cancel routes. Nonetheless, there are encouraging signs elsewhere. Passenger volumes on Greyhound are benefiting from long-distance travellers switching from cars and low-cost airlines. Top-line growth is also being boosted by the relaunch of its website, with the internet accounting for 25% of ticket revenue. In Britain its rail operations are up a creditable 5%, while growth on the bus side is steady at 1.4%.
FirstGroup (LSE: FGP), rated a BUY by Liberum Capital
All told, FirstGroup is on track to achieve its cash and profit targets for the year and to lift its dividend by 7%. The City is forecasting 2010/2011 turnover and underlying earnings per share (EPS) of £6.4bn and 41p respectively. Given its utility-like qualities, that’s good value and puts it on an undemanding p/e ratio of less than eight with a chunky 7% yield. I’d value the company on a 5.5 times EBITDA multiple. After adjusting for the £2.2bn of net debt and a £350m pension hole, that suggests a price of 385p a share.
As for risks, debt levels need to be monitored. There are also the usual issues of refranchising, margin pressure, diesel-price hikes and exchange-rate fluctuations. But none of these should cause a major road-block. With about 60% of fuel requirements hedged for the next 12 months at roughly $90 per barrel, Firstgroup looks like a cheap income play. Liberum has a target price of 409p and preliminary results are scheduled for 11 May.
Recommendation: BUY at 317p