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

Hi. Good morning, everyone, and thank you for joining the call following today's announcement. I will give a brief overview of the acquisition, including our strategic rationale on RATP London and on the London bus market as a whole. I will then hand over to Ryan to take you through the financial highlights before I wrap up and we take your questions. Starting on Slide 2. We were delighted to announce this morning that we have signed an agreement to acquire RATP London. This is a significant acquisition for us, which will see us enter the London market at scale, further diversify our portfolio and materially grow our earnings in the medium term. As we have highlighted on the slide, the enterprise value is GBP 90 million, which is underpinned by around GBP 100 million of physical assets. Ryan will go into more detail on this in his section. We expect the business to be broadly earnings neutral in financial year 2026 and operating cash flow positive from financial year 2027. There is a strong strategic rationale for the acquisition of RATP London, a well-established business with considerable market share and a strong operational footprint. These include further growth and diversification of our operations and earnings, entering an attractive market at an opportune time and further growth opportunities through a number of potential synergies. The acquisition also provides strong credentials for future U.K. regional franchise bids. RATP London's relatively new management team are also expected to join FirstGroup to continue the delivery of their proven turnaround plan. Turning now to Slide 3 with an overview of the business. RATP London is one of the larger operators in London with a circa 20% market share. There are around 3,700 employees across the business, of whom just over 80% are drivers. They operate around 1,000 buses out of a well-established depot network in West and Central London. These include 6 leased depots and 4 owned. You can see the locations on the right-hand side of this slide. The majority of the senior leadership team have joined over the last few years and have developed and implemented a turnaround plan that includes enhanced contract bidding and improved operational and cost performance. They've made good progress to date with disciplined rebidding for routes, including the early termination of loss-making routes at contract review dates. And they have been achieving top positions in recent Transport for London's Bus Operator League Tables. One of the attractions of the business for us is their progress and capabilities in electrification. They have been an early mover. And at the end of March this year, they stood at circa 30% EV fleet penetration compared to an average of 16% for the London market as a whole. RATP London also reported revenues of GBP 271 million in 2023. Moving on to Slide 4, where we have set out some of the key highlights of the London bus market. We're pleased to be entering the London market and at a time where we see great opportunities ahead and an established resilient market with a positive growth outlook. I won't go into detail on each point. But as you can see from the numbers we have given on the market, the London bus market is considerable in terms of revenues, fleet and modal share. This is underpinned by a strong funding commitment from Transport for London. Looking at demand, we have flagged some of the growth drivers for volumes over the next few years. These include continued population and tourist volume growth, bus priority measures to enhance services and to drive modal shift. TfL also has an ambitious decarbonization agenda, which should further support volumes. I will now hand over to Ryan.

Great. Thanks, Graham, and good morning, everyone. I'll be talking through the financials for the acquisition that has been agreed at an enterprise value of GBP 90 million, and this will be financed with GBP 45 million of our cash and the balance on the assumption of RATP London's asset-backed vehicle finance leases of roughly GBP 45 million. As Graham noted, what really has impressed us about the business over and above the strong operating model is that the profit recovery is well underway, driven by the turnaround plan that includes enhanced bid discipline with an incrementally improving contract base combined with much improved operational performance and cost focus. In terms of near-term financial performance, assuming the transaction closes before our March 2025 year-end, the contribution from the business will be broadly earnings neutral in full year '25 and full year '26, and I'll discuss this in more detail on the next slide. The business has gone through a period of losses in recent years given the material inflation impact, mostly in wages, that has not been fully recovered through the contractual inflation protection mechanisms. That being said, the profit recovery is well underway, driven by recent contract awards and cost base remediation. And we anticipate revenues will grow to roughly GBP 300 million to GBP 350 million over the next 5 years. It is anticipated that margins should also improve to roughly 6% to 7% over the coming years as the old contracts are replaced with these margins being in line with historical London levels. The contract portfolio currently consists of circa 40% that have positive earnings contribution with the balance currently loss-making given that they were entered into before the material cost increases driven by the reaction and response to the COVID pandemic. As a result, the group will recognize an onerous contract provision of circa GBP 40 million to GBP 50 million that will unwind in line with the respective contracts, meaning there won't be a material negative impact to the P&L going forward. Given the losses that are being incurred that need to be funded, overall, we anticipate an operating cash outflow of circa GBP 30 million after bus operating lease payments and CapEx in the first 2 years of ownership, following which the business is expected to be operating cash positive from full year 2027 onwards, assuming continued use of operating leases to finance the buses that has been the recent norm. The business has 10 depots, of which 4 are owned with an existing use value of circa GBP 50 million. There are a further GBP 50 million in physical assets, which provide a decent underpin to the acquisition value. The acquisition is expected to complete in the first calendar half of 2025, with this subject to the usual completion requirements combined with French government approval. Turning to Slide 7 as we take a closer look at the contract portfolio. As I mentioned on the previous slide, we anticipate the business revenues growing to circa GBP 300 million to GBP 350 million per year over the coming years as the newer contracts reflect the more current cost base and the shift to the higher overall cost of electrification on the newer fleet. At the point of acquisition, we expect circa 40% of the contracts to be profitable with 60% having an onerous contract provision. As you can see on the top chart on the slide, the onerous contracts reduced steadily over the coming years and are replaced by new contracts. As a result, only 22% of revenues for full year '26 is in the process of being bid for. The average maturity of the contract base is currently 3.3 years, and this is slightly shorter than normal given that a number of contracts were reevaluated at the midpoint as a result of the structural shift in the cost base that had not been expected. These midpoint reviews of contracts have a shorter time period as a result, meaning more will be up for renewal in a few years, as is the case with many operators. The evolution of the contract base, combined with the operational progress that has been demonstrated to date, provides us with confidence that the business will get to the more normal margins expected by London operators in the near term. And finally, guidance for full year '25 and full year '26. We anticipate that the acquisition will be adjusted earnings neutral for full year '25 and full year '26 before being more meaningful contribution from full year '27 onwards as the profitability grows to more -- the more normal 6% to 7% operating margin. The business will, however, contribute positively to bus adjusted operating profit in full year '26, albeit at a lower margin given the onerous contracts. We expect to incur circa GBP 6 million in interest expense. This includes both the interest on the acquisition net debt but also from the IFRS 16 interest on existing bus operating leases. The CapEx should be negligible impact on full year 2025. However, bus CapEx is now expected to be GBP 125 million in full year '26, up from the GBP 100 million that we guided earlier in the year, with this mostly being spent on electrification in our regional bus business and on electrification infrastructure in London. The assumption for London is that the electric buses being acquired will initially continue to be financed under operating leases. However, given our wider experience in bus electrification, we will critically review this given the battery pricing and potential value given up in a lease model. We will update the market in due course if there is a shift in approach to vehicle financing. On this basis, we anticipate ending full year '26 with an adjusted net debt position of circa GBP 130 million. That is roughly 0.5x cover, adjusted EBITDA to net debt, leaving the group with plenty of balance sheet capacity to continue being opportunistic in the market for further inorganic growth opportunities. As a reminder on the framework and policy for shareholder returns, the current GBP 50 million buyback program will continue, and we remain committed to our progressive dividend policy that's currently around 3x adjusted EPS. I'll now hand over to Graham for some closing remarks.

Thank you, Ryan. I will now briefly conclude before we take your questions from the call. Moving to Slide 10. This is a significant acquisition for the group that will transform First Bus and allow us to further diversify and materially grow our earnings in the medium term. It will allow us to enter the London market, which, as I set out earlier, is at a key inflection point with a positive growth outlook. RATP London is a resilient business with a strong market position and depot footprint, and we look forward to working with their highly experienced and capable management team to continue the delivery of the proven turnaround plan. Looking further ahead, as the regional bus market evolves, the experience we gained in the London market will further bolster our credentials when participating in future franchising opportunities in regional bus. Finally, as we said at our half year results in November, the group is well positioned as our markets and portfolio continue to evolve. Our strategic framework is focused on delivering operational excellence every day, driving modal shift, leading in environmental and social sustainability and diversifying and growing our portfolio. We have also maintained our balance sheet capacity and continue to evaluate a pipeline of growth opportunities in both bus and rail. We remain committed to our disciplined capital allocation policy, and we'll return any surplus cash to our shareholders. Thank you for your time this morning, and we will now open for questions. [Operator Instructions] Thank you for your time.

Ruairi.

A question from Ruairi.

A few questions on the earnings potential of the business. So is there much further work to be done to get the business up to 6% to 7% margins? Or will it come quite naturally as contracts are rebid? How would you describe the competitive environment in London when rebidding? And could I just confirm the synergies are additive to the 6% to 7% margins? And are there any comments you can make on the potential size of the synergies?

Okay. Ryan, do you want to take that?

It's all nicely financial, Ruairi. Thank you very much. I think the EPS potential, we've guided the revenue for the business should grow from up to about sort of GBP 300 million to GBP 350 million over the coming years. And that's really just a natural impact of the change in the cost base, which has impacted all London operators, as well as a consequence of the electrification. And the evolution of the onerous contract provision on that sort of 60% of contracts, as you saw in the earlier chart, will naturally contribute to earnings growing or operating profits growing at least by sort of that 100 basis points per year is our expectation. And we've given you a guide on what the interest impact is as well is roughly around about GBP 6 million. So it translates to being a really decent positive EPS trajectory for the business over the coming years. To your question on sort of the competitive landscape from a bidding perspective, I mean, London is a fairly competitive market to be operating in. But I think location of depots is key to be successful. And the team from the diligence that we've done have been as successful as they should be relative to their strong positions. And so we kind of expect that to kind of broadly continue. They've won some really big contracts recently. They've recently won the biggest contract in London, which is a great coup for them, which is obviously a decent underpin as well. And then on the synergies, we've guided on a number of potential synergy opportunities. And they're sort of ranging from procurement, advertising, the energy play that I discussed briefly in the presentation. But we've also got our business Ensignbus, which takes a large number of London buses and converts those to recycle them back into the market, which will be a positive play for us as well. And those synergies are expected to be additive to the sort of margin threshold of 6% to 7%, which we believe are sort of more normal margins for London bidding. And then I think there's a point that's sort of financially led. The business has obviously been historically tax loss-making. So we will have the benefit of that on a go-forward basis. So whilst the EPS will have the tax impact against it, we wouldn't expect to be cash tax paying for a number of years given the historical losses that the business will be working through over the coming years.

And I think just to reinforce, on renewals, they have been competitive and winning the majority of what they've been bidding for over recent times. And as an overall business, we will remain very disciplined on margin. If you can go back a period of time, 2, 3 years, the aim of the business was -- the bus business was to get to a 10% operating margin on roughly GBP 100 million of revenue. We've now managed to grow the business beyond GBP 1 billion of run rate revenue, and this takes us up another circa GBP 300 million as well. So this will be about absolute margin progress in the bus business, but we will maintain -- the disciplined approach we've taken on regional bus will be applied to RATP London as well.

Gerald.

A couple from me, if I can. Did I hear you right that you said that there's a bulge in contract renewals as a result of [ exercising the fleet clauses ]? And if so, when does that hit? And secondly, could you -- are you able to give a figure for the contract renewal rate over the past 2 years as the business has been going through this attempt to reprice to mitigate the cost inflation?

Yes. I mean on the contract renewal bulge, I think you can probably see it quite neatly on that chart that I've shown on the percentage of revenues. And you can see sort of the evolution of the not yet contracted bars in terms of the step down. It's broadly about sort of 2 years. I think you probably describe it as when the small bulge is. But remember, the kind of the average on the London contract would be roughly about 7 years with them having a contract portfolio average of 3.3 years. When you say bulge, I mean, it is a really, really small bulge. So that's not something that sort of troubles us at all, Gerald. And then in terms of sort of bidding margins, I don't think it would be right for us disclosing that on the call, but just to say that it's back to kind of more normalized levels that you'd expect in London.

So I was just wondering, what percentage of contracts were retained rather than what margins we were doing it at?

Yes. No, sorry, a high proportion is generally retained. They've got a strong operating platform. And as Graham noted in his section of the presentation, the quality of the business is incredibly high as well. So they score very well in that regard. And so the retention rate is high, and they've been quite successful.