It is not only passengers that National Express is struggling to win back on board — investors are still sceptical, too. Shares in the FTSE 250 constituent languish at roughly half their pre-pandemic level.
Wariness around near-term earnings is reflected in an enterprise value of only 5.7 times forecast earnings before interest, taxes, depreciation and amortisation for this year, far below the average multiple over the past decade.
The public transport operator needs to prove it can restore passenger levels to pre-pandemic levels, combat inflation and generate growth without sacrificing too much margin or hurting the balance sheet.
A bid for rival Stagecoach is designed to address the last of those three. National Express reckons its all-share offer can produce annual synergies of roughly £45 million by cutting duplicate back office and management functions, and by using Stagecoach’s bus depots to operate its own coach network.
National Express might feel pressure to up its bid, which was at an 18 per cent premium to Stagecoach’s share price the day before the offer. But the tie-up would be “a nice-to-have rather than a must-have”, Liberum analyst Gerald Khoo said. It doesn’t necessarily fit with the direction in which the transport operator is travelling, expanding in North America and via its ALSA business, which operates across countries including Morocco, Spain and Switzerland.
It’s not like National Express can’t afford it. The balance sheet looks secure enough, with interest cover and leverage ratios well within tighter covenant limits set to be reimposed later this year. The plan is to reduce leverage to a multiple of 2.5 by the end of this year and a multiple of 2 by the end of next, which would allow it to reinstate the dividend, twice covered by earnings, at this year’s full year results.
Management is eyeing a pipeline of investment opportunities that are worth roughly £2.5 billion in revenue, which it hopes to fund predominantly with cash generated by the business. The business is generating free cashflow again, at £123 million last year, and revenue has been steadily recovering. By the fourth quarter of last year it stood 9 per cent below the 2019 level and management reckons the gap will have fully closed this year.
The more fundamental question is where growth comes from once/if revenue returns to pre-Covid levels. Rebuilding cashflows trumps profit expansion at present. Save for the Stagecoach deal, it is targeting growth in asset light businesses, such as German Rail, where it doesn’t own the rolling stock, and its North American school bus operations, where revenue is contracted rather than determined by passenger volumes.
What does that mean in practice? There might be some margin pain in the near-term, exacerbated by efforts to entice more passengers back onto buses and coaches by holding fares down. The average margin targeted over the five years to 2027 is 9 per cent, below the typical pre-Covid margin of 10 and 11 per cent. Investors can expect that to be some way lower this year. Brokerage Liberum forecasts an operating margin of 6.6 per cent this year.
For transport operators, which have a high level of fixed costs, there is a security benefit in contracted revenue, which accounted for roughly two-thirds of the group total prior to the pandemic. The drawback? Less chance to cut costs and raise fares. National Express has hedged all its fuel costs for this year, but in areas such as US bus driver wages, rising costs are a bigger issue.
It will take more than clinching Stagecoach to win back investors.
Advice Hold
Why The discount attached to the shares rightly reflects likely margin pressure and uncertainty over recovery in passenger numbers
Henry Boot
Complex operating models don’t often play well with investors but this land promoter-come-housebuilder-come-industrial property developer has no plans to break up its multi-layered business. Why should it, asks Tim Roberts, chief executive. Henry Boot’s total shareholder return in the past 20, 10 and 2 years has beaten the FTSE All-Share over each period.
There is less risk from operating in more than one segment of the property market, too, he reckons. But performance is still more heavily linked to the fluctuating fortunes of the economy than companies operating in many other sectors, as the sharp underperformance of the index in the decade after the 2007 market crash and months after the Brexit referendum attest.
Post-pandemic, that’s been a boon. Pre-tax profit more than doubled last year. That prompted Numis, the brokerage, to raise its forecast for this year by 7 per cent to £47.5 million, from £35.1 million last year.
The strength of the housing market benefits the business in two ways. First, via the average selling price it can achieve on the houses it builds and sells via its joint venture Stonebridge Homes brand, which 72 per cent pre-let or forward sold for this year. Like peers, the housebuilding business has suffered from planning delays, but an increase in land with planning permission means it has raised its completion target to 200 this year, from 120 last year. Second, its land promotion business, which sells oven-ready plots to housebuilders, benefits from a rise in the average gross profit per plot, which grew by a fifth last year.
Housing demand and inflation could cool this year, but even if sales prices are running at a mid-single digit rate then that should be enough to offset the impact of rising costs, Roberts reckons. This year the impact of inflation should be net neutral, he thinks, with about 89 per cent of its development costs fixed. Ferocious demand for industrial and logistics assets — 75 per cent of its development pipeline — should also protect profit against rising inflation.
Plans to put more cash into new developments this year could bring returns on capital close towards its 10 to 15 per cent target range.
Advice Buy
Why Rising net asset value growth could drive further recovery in the shares
