Why FirstGroup shares just extended 2019 gain to 50%

by Graeme Evans from interactive investor |

Our companies analyst correctly called the revival of FirstGroup which just hit a two-year high.

Without a dividend since 2013, FirstGroup (LSE:FGP) has taken a big step towards shedding its "zombie" status by unveiling plans to focus on two key North American markets.

Chief executive Matthew Gregory's new strategy involves selling Greyhound coaches and creating a separate future for the UK bus division, with future involvement in UK rail also dependent on an improvement in the industry's risk and reward balance. Emphasis will be on the First Student and First Transit businesses in North America.

The dramatic shift looks to be a triumph for shareholder activism after US-based Coast Capital used a near-10% stake in FirstGroup to press for the company's UK and US assets to be split. They have also been demanding the removal of several directors, including Gregory and chairman Wolfhart Hauser.

Coast's campaign has contributed to FirstGroup shares rising by a third so far this year. They were up as much as 13% at 125p today, although the break out of the range of 80p-120p, where FirstGroup has been trapped for almost two years, was only brief.

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

The stagnation reflects the "zombie" term used by our own Edmond Jackson to describe FirstGroup as a company so burdened by debts and operational challenges. With little in the stock for shareholders following a lengthy freeze in dividends, he said FirstGroup existed mainly to pay debt interest charges and pensions, as well as to provide customers with services and employees with jobs.

But if capitalism works effectively, Jackson argued in his Stockwatch column last November, "something has to give". And so it has proved, justifying his 'speculative buy' at 83p.

FirstGroup - with its wide spread of interests - currently has a market cap of around £1.4 billion, with today's annual results recording net debt of £903 million and a pension deficit of £307.2 million. Net finance costs decreased to £106.6 million, helping to lift adjusted earnings per share by 17.1% to 14.4p.

Today's proposed strategy partly unwinds FirstGroup's transformative acquisition of Laidlaw International in 2007, when the UK business spent US$3 billion on becoming the largest operator of yellow school buses in North America, and owner of Greyhound long-distance coaches.

While Greyhound has recently shown signs of a trading improvement after previously being hit by competition from low-cost airlines, FirstGroup believes value for shareholders is best delivered by seeking new owners for the business.

FirstGroup's two other North American operations are contract-based businesses, with similar attributes and opportunities to generate sustainable value and growth. FirstTransit is one of the largest providers of airport shuttle services in the United States, while its university shuttle buses serve several Ivy League colleges.

The yellow bus operator FirstStudent, which has more than 1,100 different contracts in 470 locations, improved margins substantially to 9.5% in 2019 through a rigorous returns-based contract bidding strategy and cost efficiencies.

Together the two businesses generated 60% of the group’s operating profits in 2019, with First Student achieving a surplus of £173.5 million. 

FirstBus in the UK has also improved margins to 7.5% in 2019, but there are limited synergies with other businesses in the group, which is why Gregory thinks that now is the right time to pursue alternatives.

The UK rail franchise portfolio has generated £330.9 million in adjusted profit to the group over the last five years, but Gregory said there were concerns about the current balance of risk and reward being offered. He is waiting to see if the Williams review into the UK's rail franchising system addresses these and other industry issues.

FirstGroup, which runs First Great Western and started the South Western railway franchise in August 2017, recorded a rail profit of £72.3 million for the year just ended but expects a smaller contribution in 2019/20. It added that payments associated with network unavailability due to infrastructure improvements and repairs will continue to cause swings in profits.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. 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.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

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