The company was disqualified from bidding for the East Midlands franchise, which it is currently operating until August, as well as joint bids for South Eastern Trains and the West Coast Partnership.
The FTSE 250 transport operator saw its stock slump 11.5% to 117.9p in late afternoon as markets digested the now likely prospect that the company’s rail arm could completely disappear by November when its last franchise ends.
Despite what seemed to be a hard knock to the company, after all losing an entire business arm is less than ideal, analysts at RBC thought that exiting rail could actually leave the group better off in the long run.
In a note, the Canadian bank said the company could be better off now it was removed from what they said was “a seemingly unpredictable DfT contract-award process”.
The bank cited the decision by the DfT to award the East Midlands franchise instead to Dutch operator Abellio, which it said was “perplexing” given the company’s struggles with its ScotRail operation where it is facing an early termination.
The bank is rating the group at ‘outperform’ with an expected share price of around 145p, a premium of 18% on its current level.
“Beyond the knee-jerk reaction on lower short-term [earnings per share] potential, we see scope for [price-earnings] multiple expansion - where worse than the net outcome is already priced in.”
Pension pot dispute boils over
The cause of Stagecoach’s disqualification boiled down to concerns over its ability to fund relevant sections of the Railways Pension Scheme, which the pension regulator said would need rail companies to stump up a total of £5bn-£6bn to plug a gap in the scheme if government support ends.
Stagecoach said bidders were asked to bear full long-term funding risk for the scheme, an arrangement it refused saying the private sector “should not be expected to accept material risks it cannot control and manage”.
It wasn’t the only company to be struck off either, with Virgin also being disqualified from bidding for the West Coast franchise, which it currently runs in partnership with Stagecoach.
However, RBC said that accepting the pension liability meant the firm would have risked “not fully known” payments that could have eliminated any positive cash inflows from the franchises, and that through disqualification it was now “away from unknown contingent liabilities”.
After exiting rail, Stagecoach will be left with its bus operation, which includes services in both the UK’s regions and in London.
In a trading update on 3 April, the company reported a 3.4% increase in like-for-like revenue for the UK regional bus operation while the London bus business grew 1.3%.
The group has also agreed to sell its struggling US arm in a US$271mln deal with Project Kenwood Acquisition following a poor performance and plans to use the funds to pay down debt.
If Stagecoach has some of this cash available once it finds itself a few rail franchises lighter, it could potentially pull off a performance similar to fellow FTSE 250 firm and pure-play bus operator National Express Group PLC (LON:NEX), which hiked its full-year dividend by 10% in February after delivering record profits on the back of higher revenue and international expansion.
With RBC forecasting a 21-year price-earnings ratio (PER) for Stagecoach of 13.3x ex-rail, similar to NEX’s PER over the last five years of 13x, the bank’s analysts seem to think the same way.