Share tips: A classic counter-cyclical play

published 6 February 2012

FirstGroup, the world's leading transport operator, carries some 2.5 billion passengers annually in Britain (54% of EBITDA) and North America (46%). This is a classic counter-cyclical play as thrifty households ditch their cars to save on fuel. Indeed, the Association of Train Operating Companies says 2011 was the busiest year on the railways since the 1920s. Meanwhile, the AA has calculated that drivers have cut their petrol consumption by 15% since the financial crisis hit.

In Britain, FirstGroup runs several regional bus companies and has roughly a 20% market share. It also operates five rail franchises: Great Western, ScotRail, TransPennine Express, First Hull and First Capital Connect. In the US it owns the Greyhound intercity coaches, the yellow school buses, and manages transport systems on behalf of metropolitan transit authorities.

The company's board says all five divisions are en route to success, with like-for-like sales up 5.9% for Greyhound and 8% for UK rail. The City is forecasting turnover and underlying earnings per share (EPS) for the year ending March 2012 of £6.5bn and 40p respectively. This looks too cheap, given First's utility-like qualities, its paltry price earnings (p/e) ratio of less than eight and the 7% yield, which is 1.6 times covered.

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FirstGroup (LSE: FGP), rated OUTPERFORM by RBC Capital

Moreover, the board intends to increase the payout 7% per year, comfortably ahead of inflation, while also reducing its £2.1bn debt pile. So I would value the stock on a six-times EBITDA multiple. After adjusting for the £261m pension deficit, that delivers an intrinsic worth of 370p a share.

The biggest threat in the near term is the renewal of the Great Western and Thameslink franchises to cover the next 15 years. I expect the company to retain these contracts, albeit perhaps at lower margins due to enhanced interest from overseas rivals. Besides, this issue has already been baked into moribund analyst forecasts. There is also an ongoing regulatory investigation into alleged price fixing across the British bus sector. The findings should be released shortly. Net borrowings (at 2.5 times EBITDA) and fluctuations in diesel prices and foreign-exchange rates also need to be monitored.

Broker RBC Capital has a target price of 450p, and a pre-close trading statement is due on 29 March.

Disclosure: I own shares in Firstgroup.

Rating: BUY at 312p

Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments. See www.moneyweek.com/PGI , or phone 020-7633 3634 for more information.

Paul gained a degree in electrical engineering and went on to qualify as a chartered management accountant. He has extensive corporate finance and investment experience and is a member of the Securities Institute.

Over the past 16 years Paul has held top-level financial management and M&A roles for blue-chip companies such as O2, GKN and Unilever. He is now director of his own capital investment and consultancy firm, PMH Capital Limited.

Paul is an expert at analysing companies in new, fast-growing markets, and is an extremely shrewd stock-picker.