ii view: FirstGroup's journey higher continues after rail news

This transport operator suffered during the pandemic but has made a good start to 2023. Buy, sell, or hold? 

Rail franchise contract extension

ii round-up:

Rail and bus service operator FirstGroup (LSE:FGP) today announced a contract extension for its South Western rail franchise.

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The Department of Transport has decided to extend its operating contract for a further two-year period. The franchise, which began in May 2021, will now run until May 2025. 

FirstGroup shares were in positive territory lunchtime Friday, having come into this latest news up by 9% since the start of the year. Fellow FTSE 250 transport operator National Express Group (LSE:NEX) has fallen by 5%, while the UK focused mid-cap index itself has risen by more than 5%. 

Having previously sold its businesses in the US including the iconic Greyhound bus service, FirstGroup today operates purely in the UK. Its fleet of 8,700 bus and rail vehicles carries nearly 1.5 million passengers per day, with its rail franchises also including Avanti West Coast, Great Western Railways (GWR) and the TransPennine Express (TPE) to Manchester Airport.  

Earlier in February, FirstGroup, which is the UK’s second largest regional bus operator, added to its empire, buying Essex based coach provider Ensignbus for an undisclosed sum. The deal brings a fleet of 55 relatively new vehicles, along with a vehicle refurbishment and re-sale operation, and a high value depot.

Full-year results to the end of March are likely to be announced in June. 

ii view:

Started in 1986 and headquartered in Aberdeen, FirstGroup is today the UK’s largest rail operator with services generating just over four-fifths of total group revenues. Its UK bus services, accounting for the balance of sales, serve two-thirds of the UK’s 15 largest conurbations. 

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It is committed to operating a zero-emission bus fleet by 2035 and to not purchase any new diesel buses after 2022. Its rail business supports the UK Government’s goal to remove all diesel-only trains from service by 2040. In 2022, it was named as one of the world's cleanest 200 public companies for the third consecutive year.

For investors, elevated costs, industry-wide driver shortages and potentially higher staff wages given ongoing union strikes are affecting margins and cannot be overlooked. The geographical diversification enjoyed by its major rival National Express warrants consideration, as do political risks and possible changes of government when the goal posts for transport operators can move.

More favourably, mass transportation easing congestion and potentially taking fume emitting vehicles off the road gives it green credentials. The previous sale of its US business has strengthened its balance sheet, with an expected year-end adjusted net cash position of £70-80 million forecast, while the dividend yield is expected to increase from 1% to around 2.2%. 

There are many variables which can hinder transport companies and make them higher risk. Green credentials and strong cashflows do support growing shareholder returns, but investors will really want to see evidence of margin improvement here.

Positives: 

• Environmental credentials given a need to reduce fossil fuel emissions
• More focused business

Negatives:

• Industry strike action
• Subject to political change and risks

The average rating of stock market analysts:

Buy