Stagecoach beats FirstGroup for slim rail sector pickings

Shares of Stagecoach Group are the best performers on London’s stock exchange today on news the train operator won a fiercely contested contract to run trains between the capital and Scotland.

The rail operator beat its main rival FirstGroup in its joint win of the InterCity East Coast rail franchise, in partnership with Virgin Trains.

The UK government is returning the East Coast line to private control after five years in state hands.

The winning pair beat out the other two shortlisted bidders, UK-based FirstGroup, and a JV controlled by the French state railway company SNCF comprised of French transport firm Keolis and Channel Tunnel train operator Eurostar.

£3.3bn will be remitted to the exchequer by Stagecoach-Virgin over the eight-year contract, which starts in March, and the operators will invest £140m, adding more services and capacity.

Stagecoach controls the winning JV with a 90% stake, whilst the partnership also runs the West Coast rail line between London and Scotland.

The line franchise awarded today contributed payments of £217m to the Department of Transport in the 12 months ended 31st March 2014.

The award does not come without lingering political risk, with the line having been a hot potato for various administrations since UK rail privatisation began in the 1990s.

The Opposition Labour Party together with transport unions has attacked the return of the line to the private sector arguing that it has been contributing healthy returns to the public purse.

Train operators lag UK transport sector

FirstGroup’s loss of the bidding represents the fourth franchise it has failed to win this year.

This has served to underscore the widening investment gap between it and its bigger rival Stagecoach.

The market values Stagecoach on a prospective Enterprise Value-to-EBITDA (earnings before interest, taxation, depreciation and amortisation) of 7.5 times, whilst FirstGroup’s is currently 4.5 times, below close peers ranked on average at 5.3.

FirstGroup’s sliding prospects may be fairly well represented by the fact that its trailing five-year EPS has contracted 27%, whilst Stagecoach’s has softened by 0.2%.

Whilst the merits of a pair trade need to be evaluated on several factors, it’s interesting that a pair trade of long one token Stagecoach share against a short of one FirstGroup would have depreciated over a year.

This is quite in keeping with the fact that whilst Stagecoach appears to be on a winning streak, it is in a segment that may be lagging behind a wider UK travel and transportation sector.

Thomson Reuters’ UK Passenger Transportation Sector Index has gained a net 16% in a year, whilst FirstGroup has lost 4% and Stagecoach is up 11%.

Trailing net margins in the train operator segment seem to be under 4%.