Mr Market giving you a kicking now and again keeps you suitably humble. Back in August I self-congratulated HERE about how 'one of my better portfolio performers year-to-date has been FirstGroup (FGP) which I have loved up a number of times in the last eighteen odd months on these pages, ever since the bus and rail company was silly enough (admittedly under a different management team) to turn down a bid from private equity'. Well that was all fine and dandy with both an activist shareholder AND the company coming up with its own plans to create value by splitting the company up. However a latest update has pushed the shares down 20% odd percent as I write. So what has gone wrong given the value creation plans continue apace and full year numbers were reconfirmed?
Well it all rests on the quality and certainty of numbers. We often talk about the challenges of 'adjusted' numbers and there is plenty of equivalent red ink in the update, including a £124 million writedown on the value of its American Greyhound bus business, from a perspective that immigration flows in the US slowed to a five-year low in the second quarter. This was supplemented by higher US motor insurance costs with legal judgements increasingly in favour of claimants 'and punitive in certain regions'. Additionally there were the negative impacts (as many companies are facing) from the first time adoption of IFRS 16 lease accounting. Combine it all together and despite good First Bus trading in the UK, the company pushed deeper into losses during the six months to the end of September.
Yes, it noted that 'first half trading mainly reflects the highly seasonal nature of the Group’s operations, given the timing of the North American school holidays in our First Student business'. And - yes - it is still talking the talk on cost reductions and being 'intent on realising value for shareholders and will actively manage our entire portfolio by all appropriate means'. But what about the balance sheet, which historically has caused such problems for FirstGroup? Well, net debt: EBITDA 'relevant to the Group’s banking covenants' was flat at 1.6 times, albeit that the IFRS 16 lease accounting change added a cool £1 billion to the net debt level. An alternative measure showed rail ring-fenced cash adjusted net debt: EBITDA at 2.3x (H1 2018: 2.2x). Yes, the lease accounting changes impacted (positively) ebitda and working capital issues should reverse, but you get the point regarding clarity and comfort for investors.
So if you are a bear, you will say it is another indication of the company's inability not to generate impairments and writedowns. You will also point to the patchier cash flow generation in the first half. Bulls will point out to the company's maintenance of its trading expectations for the full year. Both sides will agree that the next six months are absolutely imperative. Are we going to see some actual movement on the break-up / value creation strategy? And will the company be able to generate some free cash? I suggest that if you get a 'yes' to at least one of these, then the shares will be (once again) nicely north of the current 100 pence share price. Which, in short, is why I would buy here though, admittedly, the sheer lunacy of that previous management team turning down private equity back in 2018 just builds along with the time value of money.
Filed under: FirstGroup, Neil Woodford disaster, Eddie Stobart Logistics, Non-Standard Finance, Kier
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