FirstGroup plc (FGP.L) Earnings Call Transcript & Summary

Hello, and welcome to the FirstGroup Winter Trading Update Call. [Operator Instructions] Just to remind you, this conference call is being recorded. Today, I'm pleased to present Matthew Gregory, FirstGroup Chief Executive; and Ryan Mangold, FirstGroup Chief Financial Officer. Please begin your meeting.

Thank you. Good morning, everyone, and thank you for joining us on the call today. I'm joined by Ryan, by Rachael, Faisal and Nick as well as our Chairman, David Martin. We've got a couple of topics to update you on today. The launch of our disposal process for the North American contract businesses as well as an update on trading since our half year-end. Let me start with our North American contract businesses. As you know, we previously set out the fact that we had appointed advisers to formally explore all options in respect to First Student and First Transit, including a potential sale. Today, I can confirm that we've completed this review, and we have concluded that a sale of the 2 contract businesses is the best way to unlock material value for all shareholders. First Student and First Transit are well invested and leaders in their markets. They benefit from substantial scale and a best-in-class operating track record as well as unparalleled customer satisfaction and safety records. It's no surprise to us that since our announcement, we've seen significant interest in these businesses. As a result, we've been working extremely hard, in parallel with assessing all options, to prepare the business for a sale process. This preparation has been intense and has involved expert third-party consultants and advisers who've helped to design the optimal carve-out structure to be implemented and put together the detailed materials and reports appropriate for a transaction of this scale. As a result, our M&A advisers are fully prepared, and the sale process has commenced. The process will be brought to a conclusion as fast as is practicable and appropriate to maximize value for shareholders. And given a normal process and the fact that this sale would require shareholder approval, we expect it will complete during the second half of 2020. Alongside the decision to launch the U.S. sale process, we're also confirming today that the First Bus and First Rail businesses will form the core of the ongoing group. And as such, I can confirm that there are no plans to pursue a separation or sale of the Bus division. We have a market-leading position in both of these businesses, with Rail having been strengthened by the addition of the West Coast partnership, and we continue to capture the benefits of our margin improvement programs in our Bus business. Public transport has a leading part to play in transitioning to a carbon-neutral society. And with our leading position in low-emission vehicles and deep local authority relationships, we have a strong platform for the future. We're also encouraged by recent government announcements supporting significant investment in Bus and confirming HS2, demonstrating how important these vital public services are to our communities, customers and stakeholders. So having updated on the portfolio rationalization, let me give you an update on trading. At a headline level, the trading since the half year has been consistent with our expectations. Revenue is growing in all divisions other than our Greyhound business. And on a year-to-date basis, revenue is up 7.5%, reflecting the recent inclusion of Avanti West Coast since December. So a continuing story of the group's ability to generate growth. Let's go into the divisions in more detail. Student continues to see strong commercial performance with 4% revenue growth in the period driven by last year's good retention rates and above-inflation pricing. New business wins have been positive again this year, and we are winning more contracts from our major competitors than they are winning from us, which is as a result of our first-class customer satisfaction scores and safety record. We're pleased to see that our acquisition strategy continues to gather pace with 3 acquisitions made this year, the most recent of 544 bus and van acquisition in Canada that completed at the end of February. The pressure from driver shortages and wage inflation continues, but the business is in a strong position to deliver continued revenue growth and cash flow for the full year. Transit is delivering revenue growth of 6% through pricing and contract wins. We continue to lead the market in autonomous vehicle trials as well as moving ahead with our transportation network company partnerships and our Mobility as a Service offering. We previously noted driver shortages and insurance costs being a drag on margins, along with a couple of legacy claims, but cost efficiency programs are moving forward to improve H2 margins. Turning to the Greyhound business. As we discussed at the half year, the reduced flow of immigration volume into the South of the country as well as ultra-low-cost airline and other bus competition has impacted revenue, and we saw a revenue decline of 9% in the period. Significant work is being done to reduce mileage and labor cost in the short term as well as seeking new commercial initiatives to stimulate demand. With regard to our Greyhound sale process, negotiations with respect to the sale of the business are ongoing, and we will update the market as appropriate when they conclude. Moving on to First Bus. Performance has been better in this period than in the first half with revenue growing at 2%. Revenue per mile has also increased from the fare and network optimization work that we've been engaged in. The environment has been challenged from poor weather, and in particular, the 2 recent storms, but margins have improved in the period versus H1 as cost efficiency measures start to come through, and we expect more of this to come in the next financial year. I think it's worth saying that we're very encouraged by the level of discourse that we're seeing around buses at present. The GBP 5 billion funding package announced by the government supports our belief that buses have a vital part to play in achieving the country's environmental, economic and social ambitions. As a leading player in this market, we're very well placed to benefit from many of the measures announced in a number of different cities and regions. Moving on to First Rail. Like-for-like revenue growth was 4%. As ever, there were a number of moving parts in this division. We saw a very successful mobilization of the Avanti franchise in December, and we're delighted to welcome the new team to FirstGroup. And we welcome the government's announcement that HS2 program will proceed. Great Western Railway is performing strongly with the successful introduction of their once-in-a-generation timetable change, and we continue to make good progress with our constructive discussions with the DfT for an extension to our contract post 31st of March 2020. TPE experienced difficult operating conditions due to the impact of delayed new fleet deliveries, network issues as well as flooding, which affected our performance and our revenues, and we're working hard to bring service levels back to more acceptable levels. South West Rail performance continues to be challenged as a result of network rail infrastructure problems and ongoing industrial unrest. And as you know, network rail issues account for more than 70% of the delays on this line, significantly higher than on other railways. We continue our negotiations with the DfT to resolve our contractual issues. And finally, we were pleased to see that the most recent National Rail Passenger Survey showed an improvement in overall satisfaction on all of our controlled TOCs. So let's talk a little bit about the outlook. Firstly, we should cover the final month of trading before our March year-end and these numbers that we're talking about go to the end of February. I mean as it stands today, we're not seeing a significant impact on revenues from COVID-19 in our businesses, but we recognize that this is a fast-developing situation. Absent any deterioration of travel volumes before the end of March or changes in government guidance and policy as a result of COVID-19, we expect to be largely in line with our previous projections. However, it's important to note, though, that March is a very significant trading period for the group, and the COVID-19 position is developing quickly. More broadly, we continue to monitor and assess the situation and are developing our plans to manage a number of scenarios. Overall, like a lot of businesses you'll have spoken to, particularly in this sector, we can't predict how this is going to play out, particularly when you look at what's happening to Italy, for example, at present. It is worth noting, though, that we do have a different profile to other operators. For example, we're not entirely dependent on direct fare-paying passengers for all of our revenue. We do have a broad geographic spread across 40 states in the U.S.A. and many regions in the U.K. We've got more than 1,000 contracted customers in the U.S. We know that some shutdown days can be made up in our largest business, Student, but we don't know how this plays out in the event of a widespread shutdown. And for example, in Transit, we are seeing some university campuses dictating closure in April after our spring break. And also in the U.K., we do have some level of revenue protection in some of our rail contracts. But what we do know is that our businesses have good long-term prospects and have a vital part to play in both the U.S. and U.K. economies and the environmental agenda. Children will still need to be transported to school, and people will still need to travel for work, business and leisure, once this particular issue has been dealt with. So let me wrap up and summarize before opening up to questions. We've launched the sale process for First Student and Transit, and we believe that this is the best way to unlock and maximize the value in the group for all shareholders. First Bus and Rail will form the core of the remaining group in a market with very positive long-term environment for public transportation. And overall trading was in line with expectations, and we're delivering on our divisional strategies. So thank you very much for listening. And with that, let me open up for questions.

[Operator Instructions] We have a question coming from Sathish Sivakumar.

I have 2 questions. One on COVID-19. If you could just briefly explain how the contracting works in the Student and Transit business. Is there any fixed element and a variable element, which is linked to your revenue per mile or number of passenger volumes? So firstly, yes. And secondly, on the sale process, could you give us an update on Greyhound? Because based on the last update, we were -- there was supposed to be an update on Greyhound sale process. So could you let us know what is actually delaying an outcome in Greyhound sale?

Sure. Okay. Well, thanks for that question. So I think on the COVID-19 question, we do have more than 1,300 contracts in the U.S. with individual customers, and clearly each of those contracts is different. I think I would characterize it this way. So in Student, if a school is closed down for a day or 2 for deep cleaning, something like that, then it -- the treatment will be very similar to how we deal with weather shutdown. So each school has a budget for makeup days if there's shutdowns, and we would expect for a small number of days for them to be able to make that up later in the year. And as I said, it's very similar to how we deal with weather. What we're not -- what's not clear is how the environment works in the case of significant shutdowns of a whole state, whole towns for the 14-day, the shutdowns that we're seeing over here in Europe. Now we haven't seen that. As I said, it's a very fast-developing situation, and we are very geographically spread. But that's one of the areas where we don't know how that's going to play out, how many extra days will be added, reactions from parents, all of these kind of things. So smaller shutdowns, we think we know how that works, but a broader shutdown like you see in Italy, for example, is uncharted water for us. I think in Transit, we've got a number of businesses in Transit. Again, we've got a good spread of business. We have our fixed route business. We have our shuttle business, particularly -- and really, that's generally being paid for providing the service and is irrespective of the passenger volumes. Again, as I said earlier in the call, we're seeing a couple of big universities saying they want to shut down after the spring break. And we've sort of negotiated and discussed with the universities what would happen in that situation. The one area where there is a bit more sort of direct relation to volume is the paratransit business, which is around 1/3 of our business, where -- that we are paid by trip for paratransit. So again, we need to see how that plays out in the U.S. over time. As we all know, it's a very difficult thing for us to assess, for any business to really assess, and we're monitoring it and working through various scenarios for all of our businesses. Coming back to the Greyhound situation, I mean, look, we said there's a sale process underway. We said back in November that we were in discussions with prospective purchasers. Our negotiations are ongoing. And we are in very active negotiations, very detailed negotiations on that sale. Clearly, as you know, with all of these M&A processes, at the point that we have concluded a sale, we will update the market accordingly.

So just a follow-up on the Greyhound sale. Is that a scenario where maybe the First Transit and First Student sale gets done before Greyhound? And secondly, I actually have a third question. On the recent drop in crude prices, what are the benefits that you expect to see on your fuel cost?

Well, I think, look, we are in very advanced negotiations on Greyhound. So we will update that -- the market at the point that, that is concluded. The Student and Transit sale, we are saying we've done a huge amount of work for that, and we are launching that process now. So we will get out -- we are getting out in the market and telling the world -- and we have a lot of interest in it, telling the world what a great set of assets these are. So I think -- what I would say is these are very, very different businesses. The Student and Transit businesses are contractual businesses, very different dynamics than the Greyhound business, and we'll treat both of those accordingly. On the oil price side, clearly, we've said many times in the past that the oil price, particularly in America where Americans are very keen to get into their cars, does have an impact on the Greyhound business. So we know that there can be an impact on the business there. In terms of the hedging, we do hedging in all of our businesses for fuel. So we will see a different impact in each of our businesses. Anything you want to add on that, Ryan, in terms of the fuel price that I have mentioned?

No, that's correct. I mean the only business that we don't hedge fuel on is Greyhound because of the natural hedge we got against revenues. But for all the other businesses, we do hedge the expected consumption of oil.

That's right.

Our next question comes from Alex Paterson.

I've got a handful of questions for you. Shall I list them all off? Or do you want to -- should I give them sort of one at a time?

Alex, why don't you list them all off, and then we'll work out the best way to which order is best to answer them?

Perfect. Okay. Firstly, just -- obviously, we've seen a very big move in discount rates, and you mentioned the sensitivity of the insurance provisions to that. Would you be able to give a sort of a slight quantification of that? How much the relevant discount rates have moved and what that does to the provisions? And then also what that may do to what you need to do? And on the other side, obviously, you've got a lot of owned fleet in the U.K. and North America. I mean it's about 45,000 student buses. Would you look at sale and leaseback of those fleet -- of that fleet to perhaps alleviate any downside from the insurance provisions? Secondly, you mentioned the university campus shutdowns. Were you saying that you might get compensation for that? Or if not, can you give us a rough indication of what the impact would be? Just on Student and Transit, what kind of bidders would -- or are showing interest in that? Are they infrastructure funds, private equity, are they other operators? I don't know if you can give any color there. Just on First Bus, you're saying you're not pursuing your sales process. Is that because you don't think the U.K. market will consolidate much further or rather that you just don't want to be part of that at this point in time? And finally, just hopefully, you can get a very good price on the sale of Student and Transit, could you just indicate what you would do with the disposal proceeds, please?

Sure. Okay. There's a lot there. Thank you for that, Alex. Let me go through the sort of more strategic comments, and I'll let Ryan talk about the sort of the discount rate point first. So why don't you start, Ryan, with the discount rate point?

Alex, I mean, that's a really good question. I mean the provision that we've got for insurance on the balance sheet for our North American or particularly the U.S.A. operations is a long-term provision that we build up over time. It's carried on the balance sheet. And from an actuarial point of view, we've got to assess that based on a discount rate and a discount rate that has moved materially as a consequence of federal intervention in the U.S. Currently, the 10-year treasuries are sitting at about 0.69%. I think earlier this week, they were down about 0.48%. As at the half year, the discount rate that was applied was 1.6%. And so it's awfully volatile. To put it into context, for this fiscal year to the half year, the impact of the discount rates decline from full year '19 to the half year '20 was approximately $10 million going down to 1.6%. So depending on where it actually lands at the end of the fiscal year for us on 31st of March, that will determine how much of an impact that discount rates would have. But order of magnitude, it's roughly about -- where we're standing today, roughly about GBP 15 million in total impact to our earnings, of which half is taken at the half year already. Just the other point that you had in terms of sale and leaseback in order to be able to hand over the insurance costs to perhaps the lessor or to another provider, I think that, that would be quite difficult to achieve because at the end of the day, all of our lease contracts that we currently have got in place. We've got a few of them in the business. The responsibility for insurance and maintenance actually sits with the lessee, not the lessor. So I did...

Yes, I didn't mean the insurance liabilities would move. I just meant, obviously, the value of that -- your borrowing cost if you were to sell and leaseback would come down because yields have declined so much.

Yes, Alex. And for all of our acquisitions that we do make as part of our contractual commitments, for example, in Students, we do love to see what's the most efficient and effective way to finance those acquisitions, either through leases or through outright purchases because there's a lot more into it than just simply a purchase. There are sort of warranties, there's discounts availability, there's extended credit terms, et cetera, that goes into our calculation and thinking on how we actually finance acquisitions.

And I'm sure, Alex, those kind of questions will come up in the sale process. These are things that people, I'm sure, will be thinking very long and hard about as to how best to finance the fleet. So yes, possibly some opportunities there. Let me cover off the university campus piece. What I was trying to do there was just give you some examples. So we've got contracts to run buses in Stanford and in Princeton, for example. The contracts themselves are probably worth about $10 million to $12 million each on an annual basis. Interestingly, we've had very mixed messages. We've had one of them sort of say, "Well, maybe we don't come back after spring break." One of them said, "Yes, we're definitely going to do that," but then recoiled immediately because all the students are suddenly saying, "Hang on, we're paying you to provide services, so you're going to impact my studies." So there's a lot of moving parts, and things are moving very rapidly. So I wouldn't want to sort of try and say this is an example of how it's all going to work. But we just -- what we're trying to say is that we've not seen significant impact in the numbers up to the end of February, but this is moving on a daily basis. Let me just come back to then the points around the sort of the transactional side of things. So who's been interested? Well, a lot of people from a lot of different areas are being interested. So we've had interest for -- from private equity firms, had interest from strategics. We've had interest from some infrastructure funds. We've had a very broad range of interest and a lot of people coming forward to us. So I think this is the benefit of going through a process. We open up to the market, and everybody can sort of make their interest known. And we know that these are very strong assets. They are well invested, market-leading, long sort of fundamental growth prospects. We know -- irrespective of anything that's happening with COVID-19, we know that children are going to go to school next year. So these are good businesses that a lot of people want to get involved in, but they very rarely come on to the market at this kind of size. So as you can image, there's a lot of interest there. I think in terms of the First Bus piece, look, when we sort of -- when we've been thinking about the portfolio, the key issues for us is we've got 5 market-leading businesses. We've said many times that there are no synergies, but we said that there were many friction costs that we had to deal with and we had to work out the best way of dealing with that. We -- David came into the business, fresh pair of eyes. He's got a huge amount of experience in this sector. We've worked very closely together, David and I, on this project. And with Rothchild who've been doing this piece of work. And we have concluded that the best way to unlock and maximize shareholder value is through the sale of these 2 businesses. And that is sort of the primary sort of announcement we're making. We're, therefore, saying that then the core of this business is going to be our U.K. Bus and Rail business. And as I said earlier, we -- there's a lot of very positive sort of discourse around infrastructure in the U.K. So there's some very good announcements coming out of the government, GBP 5 billion of funding for bus, HS2 is going to proceed. So again, this is all about making -- unlocking the value. We think it's the best way of unlocking the value, and we just wanted to be clear to people that the core of the business is in good shape and in markets where there's some good potential. And then finally, I think the last question, I think, was just around the use of funds. Look, clearly, our objective is to maximize returns to shareholders. And we're getting a little bit ahead of ourselves. We're starting the process now. We're expecting to maximize value. We're expecting this to be very interested -- a lot of interest in these assets. We are working through plans now to determine how best to deal with the proceeds that will come out of that. But clearly, I think everyone is in agreement. I think all of our shareholders are in agreement that we need to maximize value, and we want to maximize returns to shareholders, taking into account the -- some of the legacy issues we've got to deal with.

We have another question coming from Stephanie D'Ath.

My first question is on the contract business divestment. Could you please share with us your expectations maybe worse and best case in terms of the timing? Would you expect to conclude the divestment by the end of fiscal 2021? And in terms of how much you expect to get from that business, you might not want to comment on that for competitive reasons but maybe can then share where consensus valuation is and how comfortable you are reaching that. Secondly, on your operating expenses. Could you please remind us how much is fixed versus variable in U.K. Bus and U.K. Rail? In the event of strong traffic decline as a result of the virus, how quickly can you adjust your operating expenses and to which extent are they fixed and nonadjustable?

Sure. Well, let me deal with that first question. I think the U.K. businesses, we have a very high percentage of fixed cost within the U.K. business. We are contracted to provide a schedule where -- bus schedules. We're contracted to provide rail schedules. Rail, we know that we have a huge amount of infrastructure that we're paying for, Network Rail kind of fees, all of that. And the bus business, the large percentage of cost going into the drivers, and that is what we need to run the service. So high proportion of fixed cost. But clearly, we are looking at a number of different angles and a number of different scenarios around this to deal with what is a very kind of one-off situation here about how we can impact schedules, whether -- we are talking to government as we speak, as an industry or as both industries, about how we can be more flexible in the way that we deal with our cost base. I think coming back to the divestment, look, the 2 questions, I mean, we're saying -- we have done a huge amount of work on this in the last 3 to 4 months since we've sort of announced that we're doing this review of strategic options. Because we got a lot of interest immediately, we've done a lot of work upfront with third-party advisers and contractors. So we're kind of really ready to go on this, and the process has started. Now we know that these kind of auction processes take a number of months go to through. We know that there'll be -- this is a Class 1 transaction, so there'll be a shareholder approval process, which is why we are saying we think the second half of calendar 2020 is when we'd expect to conclude this transaction. I mean we're working very hard and fast on getting this done quickly but also making sure we maximize value for shareholders. And to that point, you're right, I'm not going to talk about value. There's no point in me sort of bidding against myself for this business. But what we do know is these are extremely valuable assets. And I think everyone that we talk to, all of our shareholders that we consult with, all agree these are valuable assets. They've got long-term fundamentals. They've got well-invested asset bases. They've got good contracts spread across the entire country. And so we think these are very, very valuable assets. So again, that's why we're seeing this high level of interest in the process that we've launched today. Any other questions there?