Why bulls have chased Stagecoach shares up 12%

After a bad four years, there's evidence that the worst may be over for this bus and trains firm.

With last year's East Coast franchise debacle now behind it, Stagecoach (LSE:SGC) gave investors another reason to get back on board today by revealing signs of momentum at its rail division.

"Strong trading and positive progress" for the UK rail arm should mean earnings per share for the year to the end of April are better than it expected at interim results in December.

It's another boost to sentiment around Stagecoach shares, which have rallied sharply since announcing the proposed sale of its North American division for more than £200 million - a move that will create a dedicated focus on UK bus and rail.

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Stagecoach is already braced for a defining few months in its rail portfolio, which is currently made up of East Midlands Trains, the Sheffield tram network and a joint venture with Virgin running the West Coast franchise.

The East Midlands contract was recently extended to August ahead of a franchise renewal process, while Stagecoach is also hoping to renew its involvement on the West Coast line and is on the short-list of bidders to run Southeastern services.

Given that rail is likely to account for more than a quarter of 2019 profits, success in re-shaping the rail division should be key to underpinning the Stagecoach dividend. The stock currently yields 5%, having recently pegged its interim dividend at 3.8p a share.

Source: TradingView Past performance is not a guide to future performance 

In today's brief update, Stagecoach said Virgin Rail Group revenues accelerated to 6.7% in the 44 weeks to March 2, with the performance for the rest of UK rail up 1.4%.

Trading is much tougher on London buses, however, amid a continued squeeze on profitability caused by the "highly competitive" bidding environment on Transport for London tenders. Underlying revenues rose 1.3% in the 44-week period.

In contrast, its regional bus operations maintained their recent strong performance after like-for-like revenues per vehicle grew 4% and the figure per journey increased 3.6%.

Analysts at Jefferies said recently that maintaining the regional bus performance will be key for the company, given that it generates around 75% of non-rail operating profit.

They are encouraged by the better than expected pricing and passenger growth but have longer term concerns around trends such as working from home, online shopping and congestion.

They said last month:

"In our opinion, the negative impact of these patterns is more prevalent in Stagecoach’s operational areas, which are skewed to the Midlands/Northern England."

They have a price target of 145p, whereas RBC Capital Markets today upped its estimate from 160p to 190p and Liberum reiterated a 'buy' recommendation and 180p target.

Shares were recently languishing at their lowest level since 2009, trading on a projected 2019 price/earnings (PE) multiple of around 8x. Liberum transport analyst Gerald Khoo believes this looks too undemanding as it fails to take into account the potential for management to address the challenges faced by the group.

This was shown by the sale of the North American division, which has performed below expectations amid increased competition in some markets. Disposal of the division, which operates megabus.com and has around 2,100 buses and coaches, will cut debt and should release capital to target UK opportunities, particularly in UK bus.

The loss of revenues from the South West Trains franchise, which ended in August 2017, and the re-nationalisation of the Virgin Trains East Coast franchise last summer meant adjusted EPS in December's interim results fell to 12.9p from 13.6p a year earlier.

*Horizontal lines on charts represent levels of previous technical support and resistance.