At first sight, the Go-Ahead Group (LON:GOG) looks like a great buy. The FTSE 250 company released H1 2018 results today showing increased operating profits versus what was reported last year. The increase was primarily down to an increase in operating profit for rail journeys. Investors appeared to be very happy with the results, and the share ended up a massive 14%. However, the company currently has a suspiciously low P/E ratio at ~7.5 with a sub £700 million valuation. After seeing this, I wondered what could be the cause of such a depressed valuation. Is this a share that is genuinely undervalued? Or is this a share that a fairly valued because of the risks involved?
Go-Ahead Group has been around for over 30 years and is a leading transportation/travel company. The firm has 2 main drivers of revenue, its rail business, and its bus business. The bus business is responsible for roughly 60% of operating profit, although the rail franchises are responsible for over 2/3 of the company’s gross revenue (see the last annual report here) . The company’s revenues are predominantly generated from UK markets, but the company has also started to expand internationally and has a target for international operations to contribute 15-20% of profits within 5 years.
Let’s take a look at some of the hard stats for H1 2018:
- Bus and rail operating profit was £86.9 m – up from £73 m
- Market cap even after today’s rise is just £660 million
- H1 dividend maintained at 30.17 p
These stats look good on paper, but there are some risks that investors should probably consider before investing in this share.
- Operating profit – one offs – the company admits that the increase in operating profit for its rail business was as a result of one off rail benefits (such as the sale of London Midland assets) – by definition of one-off, the increase in operating profit is not sustainable – i.e expect a return to the norm in H2.
- Loss of franchises – the company confirmed that the London Midland franchise ended in Dec 2017 and that this will negatively impact revenue for 2018. To put this in perspective, London Midland contributed £482m in revenue in 2017. In addition, the SouthEastern franchise is also up for renewal. This franchise contributed a whopping £844m in revenue. There is no guarantee that this franchise will be retained. If this franchise was lost as well, London Midland + South Eastern would remove £1.3 billion in yearly revenue!
- Loss of passengers – The sad thing about the loss of the London Midland franchise is that this is the only rail franchise that produced increased passengers numbers for FY 2017! All other rail franchises registered declines. The company has suggested that travel patterns are changing and I agree that this is indeed the case. Other companies such as TFL underground have also reported lower passenger numbers. Technological advances have genuinely resulted in less need to travel. A significant number of passengers are persons travelling to and from work. It’s not a secret that more employees are now allowed to work from home. As conferences (both video and audio) become more common place, this practice will increase and less numbers of persons will travel into the office. From the H1 report, it appears that the bus business is also suffering from a decrease in passengers. The bottom line is: less passengers = less revenue.
- Brexit – No one really knows the impact that Brexit could have on the company but what’s clear is that there could potentially be numerous challenges that could arise. For instance, the company has recently secured new rail contracts in Germany. With Brexit, will this expansion be able to continue? Will Germany have a preference for European companies over non-eu companies (i.e the UK) post-Brexit. Will Brexit have a negative impact on labour supply? Will Brexit fears be realized with an exodus of companies and jobs in general which could translate to less travelling across the board? In the event that Brexit does not occur, could this trigger a general election and introduce a Labour government? Labour has well-known goal of re-nationalizing railways. What would be the impact of GOG if this becomes a reality?
With these sort of potential issues on the horizon, I’m surprised that the dividend is being maintained. Granted, 30.17p isn’t that much, and we’ll have to see if the full year dividend is also maintained. However, I’m even more surprised at the dividend after seeing that the company’s cash decreased to £164m (after decreasing by almost £100m in FY2017)
In summary, in my view, the share is fairly valued, given the risks involved. Of course if the risks do not materialize, an investor could potentially reap decent rewards in the coming years. For me though, I plan to stay away for now.
As always though, please do your own research before buying/selling this share; the opinions above are only my personal views.
