7th July 2009
Why National Express could be worth a look
As you'll probably have read, last week National Express decided to give up the East Coast main line rail franchise because it could not afford the £1.4bn payments that it had promised to the government for running the franchise.
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As a result of that, Lord Adonis the transport minister said that because the franchise contract contains "cross default" clauses, the government might look at ways to strip National Express of the other two profitable franchises that it runs in Essex and East Anglia. In other words, the government isn't keen to let the company simply walk away from one franchise because it's become too onerous, yet keep the two profitable ones.
As you know, I like distressed situation and this news got me thinking. In particular, I was interested to find out how much National Express could be worth if it's stripped of its UK rail business altogether.
The fact that the bus and coach business is a stable cash cow, and could even benefit in a recession as people trade down, got me even more interested.
So here's what I found out, and what my thoughts are on this situation.
The company
National Express operates in four business lines: UK rail; UK coach and buses; US coaches (including school buses); and Spanish coaches. Last year, the company generated £2.7bn in turnover and a normalized profit (I use normalized profit because that's how it's reported in the annual statement) of just over £250m.
When you break down the result by business sector, you immediately notice that while UK rail provides the bulk of the company's revenues, it only accounts for around 33% of the profit.
| Division | Turnover | Normalized profit |
| UK Rail | 1.330m | 81m |
| UK Coach and buses | 580m | 67m |
| US Coach and school buses | 372m | 32m |
| Spain | 483m | 83m |
So even if all the company's rail franchises are stripped from it, it could still survive the hit to profits would be significant, but not catastrophic.
The other interesting thing to note is that if UK rail is excluded, the foreign operation will provide 60% of the turnover and 65% of the profit. What this means is that the stock will be more correlated to foreign exchange movements, and could benefit from a weaker pound.
The sectors in which the company operates are less sensitive to the recession than many other business areas. They might even benefit as people use their cars less and trade down to save money. For example, consider the North American school bus division which should not be affected by the slowdown at all.
Some problems might arise from the Spanish operations these were bought at the end of 2007, and could be affected by the deep slowdown in the country. But according to the annual report, these activities were restructured and should provide long-term growth opportunities in a highly fragmented market.
The workforce was another big issue that used to cause problems for National Express and its rivals. The industry suffered from a shortage of qualified drivers until a couple of years ago, but in the current economic climate, wage growth should slow dramatically and more qualified personnel should be available in the labour market.
The stock's performance
National Express seems to have been badly hit by the fall in the stock markets in the first half of the year. Last year, the shares were trading for more than 1,000p each, then fell to 150p, before bouncing back to around 340p and falling to 270p now, after the news on the East Coast main line was announced. Two other things should also be noted: the first is that last year, the company had earnings per share (EPS) of 93.6p; the second is that the company is £1.2bn in debt.
The high debt load is what caused the share price to collapse in the last year, as markets shun all companies with high gearing. One last thing to note is that there are 154m shares in issue, giving a market cap of £408m. Volume is currently around 2m shares a day.
Recent news and developments
Three main developments should affect the company in the near future:
1. The first and biggest is clearly the loss of the East Coast rail franchise and the possibility that the company might lose the other two smaller, profitable franchises. The government has not said anything so far, but in my view it seems quite probable that the company will lose all of its UK rail business. For one thing, it's inconceivable that the group can be allowed to dump the unprofitable part and keep the rest. The government will be also quite keen to set a strong example, so that other rail franchisees aren't tempted to follow suit. But most of all the government will use this situation to try to score badly needed political points ahead of the looming general election.
One point to look out for would be if the government seeks damages or tries to force the company to pay the £1.4bn it owes. As you can imagine, this possibility could spell disaster for National Express. However, it's worth noting that all rail franchises are held in separate companies, which should theoretically limit this exposure.
2. The second development should be a rights issue, which the company could launch in autumn to shore up its finances and pay down part of the £1.2bn in debt it has outstanding. (Unfortunately the debt that National Express has issued is not in the form of traded bonds and this means we can only profit from this distressed scenario via the ordinary shares).
3. The third and final point could be a takeover bid from a rival. FirstGroup has already approached the company with a takeover proposal and was rebuffed. But this aborted approach tells us that the industry sees good potential for National Express's assets.
The strategy
All in all, National Express is definitely worth keeping an eye on. The company is fundamentally profitable and has stable businesses generating cash it is not a dead beat in a dying sector, or a company in a bubble industry.
The best strategy for now is to sit and wait for the negative news to come out and then buy on the dip. The government should announce its response to the nationalization of the East Coast main line soon and this will remove a big overhang to stock performance.
We should also wait for developments on the rights issue front, as it was rumored to be in the region of £500m. A £500m rights issue would get rid of the debt problem by bringing it down to around £800m, or around five times normalized profit excluding UK rail. Giving that the market cap is around £408m, a rights issue of this size could imply a large dilution for existing shareholders it could be two new shares for an old one at 160p and thus a possible drop in the share price.
Hopefully potential bidders will wait to see these two issues resolved before showing interest in the company again, but the fact that FirstGroup was interested gives me confidence that rest of the company is fundamentally sound.
I will add National Express to our watch list and let you know when I think it's time for us to make our move.
Another distressed play
Before I leave you this week, I want to draw your attention to another distressed play. Lear Corp (US: LEA), a supplier of seating and electronics systems for the car industry, filed for Chapter 11 bankruptcy last week.
The company has $1.3bn in bond debt in the form of three senior issues, two of which are traded; an 8.5% due in 2013 and an 8.75% due in 2016. Not much is known about the Chapter 11 process, but the company said that it expects to pay trade and other creditors in full, and this is generally a good sign. The bonds rallied from 25% of face value to 38% ahead of the forthcoming auction to settle the $650m in CDS (Credit Default Swaps) outstanding on the debt.
It's not time to get involved yet, but I will monitor this situation too.
On that note, my apologies for not coming up with ideas that can be traded right now, but at the moment we are heading into the summer season where activity is reduced and volatility low, so I do not expect much to happen.
I am also cautious because it seems that the markets are now unsure whether to believe the green shoots of the recovery or not, and this could have a profound impact given the size of the recent rally.
I have enjoyed the emails I have received from various subscribers and by now you should have had a reply from me - as usual, do let me know if you have questions or ideas or any other points by dropping me a line at eventstrader@f-s-p.co.uk.
Riccardo Marzi
Events Trader
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