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UK government provides support to railway stocks amid coronavirus crisis

The government is providing a safety net for the rail industry that secures its future beyond the coronavirus crisis, but that isn’t stopping companies taking prudent action in the meantime.

Railway stocks Source: Bloomberg

‘Emergency measures’ introduced to support railways

The UK government has introduced ‘emergency measures’ to protect the UK’s rail network as the industry grapples with a significant slump in passenger numbers since people were encouraged to stay at home to stop the spread of the coronavirus. This includes effectively suspending all franchise contracts for an initial period of six months and moving them to Emergency Measures Agreements.

The unprecedented action comes as the UK rail network begins to run reduced services as more people work from home and stay indoors because they are socially distancing themselves or self-isolating.

It has also struck a deal with train operators to ensure people can get refunds on tickets that were purchased in advance but will no longer be used, and to partially refund season ticket holders that no longer need to travel.

Why is the government stepping in?

As the transport secretary Grant Shapps said: ‘We are taking this action to protect the key workers who depend on our railways to carry on their vital roles, the hardworking commuters who have radically altered their lives to combat the spread of coronavirus, and the frontline rail staff who are keeping the country moving.’

The number of passengers using trains in recent weeks has plunged by 70%, which has severely hit the income of the companies that operate them. The transport secretary said total ticket sales for the industry were ‘down by two-thirds from the equivalent date in 2019’.

It has been even worse for some operators, with FirstGroup stating it had seen a 90% drop in revenue from its four FirstRail franchises - Great Western Railway, South Western Railway, TransPennine Express and Avanti West Coast.

Although people are being discouraged from travelling, the rail network needs to stay up and running during the coronavirus crisis so key workers can still travel and vital goods and supplies can still be shipped around the country. It also gives security to the industry’s staff, which could have been deemed at risk without government intervention.

Plus, the government says taking protective measures now is more effective than having to rescue them when the situation gets worse or letting them fail.

‘This is not a new model, it is a temporary solution, taking the steps necessary to protect services now in a cost-efficient way, and ensuring current events have as little impact as possible on the railway in the longer term. Allowing operators to enter insolvency would cause significantly more disruption to passengers and higher costs to the taxpayer,’ the government said.

What does it mean for rail operators?

The contracts that rail operators usually operate under have been suspended, ‘transferring all revenue and cost risk to the government’. In layman’s terms, this effectively means the government has temporarily nationalised the industry for the next six months and will absorb any losses that the network incurs during this crisis.

Rail companies will continue to operate services, albeit at reduced levels, in return for a ‘small, pre-determined management fee’ that will be ‘set at a maximum of 2% of the cost base of the franchise before the COVID-19 pandemic began’.

They will still be offered the opportunity to earn more by meeting targets related to the likes of reliability and punctuality. Still, the most any operator will be able to earn over the next six months will be ‘far less than recent profits earned by train operators’.

Importantly, this is an offer that has been made by the government rather than an order. Train companies can reject it, but it would be highly surprising if any of them decide to do so.

Although the offer severely limits their ability to make money over the short term, it provides them with the security they need to protect them in the long term. If any company does decide to reject the help then the government’s ‘operator of last resort’, which in this case if the Department for Transport, will step in and take over.

How have railway stocks responded?

There is a large group of companies operating rail lines across the UK, both from home and abroad. Importantly, many of the publicly-listed operators are not solely focused on trains but other modes of transport, such as buses – an area that has not received an equivocal package of support.

Plus, some of them offer transport services in other countries that have, for now, not offered the same help as the UK government, meaning some of their operations still face uncertainty.

Although the UK government is providing a safety net for operators, this has not stopped the industry taking drastic action to protect their balance sheets and hoard cash to see them through what will be a very difficult year. We have a look at how some of the railway stocks have responded to the coronavirus outbreak and the government’s intervention.

Go-Ahead Group prudently suspends its dividend

Go-Ahead runs trains and buses in several markets. The majority of its revenue is from the UK, but it also operates in Germany, Ireland, Singapore and Norway.

The company has accepted the UK government’s help for its GTR rail franchise, which accounts for 45% of its total revenue. The franchise on its other main UK rail line, Southeastern, which accounts for 28% of all revenue, should also benefit from the support if it is renewed at the end of the month as expected.

Overall, Go-Ahead says 75% of all revenue is ‘derived from contracted markets where there is no direct revenue risk from changes in underlying travel demand’, suggesting most of its income will be somewhat protected over the coming months. This includes its rail operations in Germany and, notably, its bus operations in London that it runs on behalf of the Department for Transport.

‘The group's financial exposure is therefore predominantly linked to the proportion of its revenues derived from demand-driven commercial services which account for around 25% of group revenue,’ Go-Ahead Group warned.

This revenue comes from its regional bus services in the UK, Southeastern, and its railway operations in Norway – but if Southeastern receives support then this would be big boost for the business.

Although Go-Ahead Group’s operations look largely protected from the downturn in travel, the company has taken drastic action and is bunkering down. It says it can’t provide any financial guidance for the rest of the financial year that will run until the end of June 2020.

Go-Ahead says it isn’t due to start paying back any of its debt until 2024, and that it has a ‘strong balance sheet with good liquidity’ to see it through these challenging times.

‘Through a combination of available headroom through our committed facilities, management action, and 75% of our revenue being protected through contractual arrangements, the group is well placed to withstand the challenges this crisis presents,’ Go-Ahead said.

Still, Go-Ahead has decided to claw back £13 million it was due to return to shareholders through its interim dividend of 30.17 pence that was declared only earlier this month. It said the decision was ‘prudent’ and that it will review its dividend policy when it has greater clarity on the coronavirus outbreak.

FirstGroup keeps dividend alive, but for how long?

FirstGroup runs trains and buses in the UK, US and Canada, and all of them have been impacted by the coronavirus as the situation continues to unravel in North America too.

The company has accepted the UK government’s help and said it ‘provides certainty’ for its UK operations. However, the company’s UK train operations, which runs four different lines, only accounts for 18% of earnings before interest, tax, depreciation and amortisation (EBITDA), which means most of its earnings aren’t safeguarded. Its UK bus operations make a similar contribution to earnings but has so far seen a 65% reduction in passengers.

It is possible that the UK government will expand its support for the transport industry to buses, but it has not done it yet. ‘We are actively engaged with the UK government, alongside the bus industry, for the purpose of securing the urgent support required including a guarantee of already budgeted sources of income for bus and coach operators,’ FirstGroup said.

The other 65% of its earnings comes from North America, where the situation is less certain.

Firstgroup makes half of its EBITDA from running 42,500 yellow school buses across 40 US states and seven Canadian provinces. The vast majority of its contracts don’t offer guaranteed minimum revenue, meaning there is nothing to help protect its operations as they practically grind to a halt as schools close and students stay at home.

Still, it said it has managed to strike deals covering 55% of its US and Canadian bus fleet. Its Greyhound arm that offers shuttle services across the US-Canada border is also struggling to operate after the two countries announced border closures.

The company has said, all-in-all, that the outlook is far too uncertain to provide any financial guidance for the year to the end of March 2020, and investors shouldn’t expect too much clarity as it enters the new year either.

In response, FirstGroup is cutting costs, imposing a hiring freeze, deferring or sacrificing management salaries and ending the use of consultants and agency labour where possible.

FirstGroup has secured extra credit lines to bolster the balance sheet with a new £250 million bank bridge facility, which is in addition to the £400 million of existing bank facilities and cash it already has in place. Net debt currently sits at around 1.5x EBITDA, well below the limit of 3.75x.

FirstGroup did not mention its dividend in its latest update, but investors should brace for potential bad news when it releases its annual results on May 28, 2020. FirstGroup is wisely using the time it has to make a decision, but it did say it will ‘take all necessary actions to preserve cash through period of uncertainty’, implying it could follow Go-Ahead Group by suspending its dividend.

What does it mean for railway stocks in the long term?

The message emerging from countries around the world is that the coronavirus is decimating the economy, businesses and the way people conduct their everyday lives, but that it is all temporary.

It is therefore unsurprising that the UK government is trying to protect the long-term future of the rail industry to ensure there is a network ready and waiting to restart when life begins to get back to normal.

As Go-Ahead’s chief executive David Brown said: ‘Once this crisis is over, strong bus and rail connections will be needed to rebuild our economy and support our communities; providing links to education, employment, retail and leisure facilities, and between friends and families.’

Still, operators are not being supported across the board. Those with international operations, like FirstGroup, are still trying to secure aide from the likes of the US government. Plus, the majority of bus services have not been treated with the same urgency as trains and still face uncertainty.

UK bus operator Stagecoach has said it expects to ‘maintain a significant proportion of our revenue during the downturn’, but says it is still in discussions with the government and local authorities. Still, it has started to cut costs and hoard cash too, stating it is ‘unlikely that we will propose any further dividend’ for the current financial year to May 2, 2020.

The prospects for the rail and bus industry is uninspiring: people in the UK and abroad will be travelling much less for the foreseeable future and revenue and profits will be impacted as a result. But the UK government is providing a safety net that virtually guarantees their survival – one that many other struggling industries wish they had.

Dividends and shareholder returns are likely to be sacrificed as a result, but at least investors know these businesses will still be in existence when the crisis is over and are in a position to immediately capitalise when life starts returning to normal.

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