Posted on: 24/06/2009 

Shares in bus and rail groups have been under pressure this year year due to their exposure to train travel, which has been hit by the recession as rising unemployment reduces commuter numbers

Stagecoach reported slowing passenger and revenue growth at its major rail businesses today but saw its shares rise 7.5% after its bus operations helped the public transport group report stronger-than-expected full-year results.

Shares in bus and rail groups have been under pressure this year year due to their exposure to train travel, which has been hit by the recession as rising unemployment reduces commuter numbers. Stagecoach said income growth at its biggest franchise, South West Trains, had slowed as reductions in central London employment and leisure travel affected ticket sales. It added that revenue increases at East Midlands Trains had also declined over the past six months.

Although revenue growth is a key metric for train operators, deflation is due to push down fares next year which makes passenger numbers an even more important factor for investors. The Stagecoach revenue numbers indicated a deterioration in passenger volumes at both franchises, according to analysts. Because fares rose by up to 6% in January, any revenue growth less than 6% at Stagecoach's franchises indicates that passenger numbers have fallen since the start of the year. SWT appeared to be the most heavily affected, with an estimated revenue growth of 3% since November indicating a 2% fall in passenger numbers at one of Britain's biggest commuter franchises, according to stockbroker Collins Stewart. East Midlands passenger numbers probably grew by just 1% over the past six months, Collins Stewart added.

Legal dispute with the DfT

Andrew Fitchie, a Collins Stewart analyst, warned that the shine would be taken off Stagecoach's share rally if the group failed to win a legal dispute with the Department for Transport over the financial terms of its SWT contract - which must pay the DfT £1.2bn over 10 years. "If Stagecoach loses, rail losses will be substantial and a dilutive refinancing could be necessary," said Fitchie. If SWT loses the case, it faces a revenue shortfall of £100m that it must make up from its own financial resources, without government help. If it wins, the DfT will have to shoulder a significant proportion of the losses.

However, the immediate market reaction to the figures was positive after the group reported a 12.6% increase in pre-tax profit for the year to 30 April, rising to £196.4m. Revenues rose 19.3% to £2.1bn. Brian Souter, Stagecoach's founder and chief executive, said the group had increased revenues at its bus and rail divisions despite a "challenging" trading environment that is putting pressure on train operators in particular. He added: "'There is no doubt the transport sector faces a challenging year ahead, but I believe Stagecoach is well placed to withstand the economic headwinds."

Gerald Khoo, analyst at Arbuthnot Securities, said the group had outperformed "across the board". He added: "We understand the market's fixation on the risks in UK Rail, but we believe it is overlooking the robust, defensive and cash generative UK Bus business, which we consider to be the best in the industry. However, we do accept that the lack of an obvious positive catalyst and ongoing adverse sentiment towards rail may mean the value gap persists." Gert Zonneveld, analyst at Panmure Gordon, warned that the air of gloom around the rail sector would continue to be a drag on Stagecoach's share price. "Given the expectation of ongoing weakness in the UK rail market in the next year or two, we favour companies which have limited or modest exposure to UK rail." Stagecoach shares were up 7.5% at 126.5p in early trading.