Lucy Tobin: FirstGroup shares could hit the buffers over threat to dividend

Investment View: The transport giant remains the only bidder shortlisted for all the rail franchises on offer


Our view Sell

Price 200.6p

The runaway train contract with no driver certainly smashed up FirstGroup's share price this week. News that the bus and rail giant is to be stripped of the West Coast rail contract due to a civil service cock-up so large three Sir Humphreys have been suspended sent First's shares down by almost 20 per cent on Wednesday. There were probably more people queuing up at one of First's ticket offices than piling back into the stock yesterday – the shares inched up just 7.2p to 200.6p.

But has it all been a bit overplayed? It wasn't FirstGroup's fault that Government pen-pushers got their numbers wrong. Their calculations of inflation, passenger revenues and the amount FirstGroup would have to pay in guarantees were wrong. But those formulae were used by all the bidders. No one is blaming First – which is Britain's biggest transport operator – and it will get millions in compensation (from taxpayers like you and me, of course) for its trouble.

The contract will be re-run – with no greater or lesser chance of First winning it – and in the meantime, the transport giant remains the only bidder to have been shortlisted for all four of the railway franchises currently on offer.

The angry commuters who bemoan First's delay-ridden running of the Great Western line or lack of investment (still no wifi across the line, unlike rivals) might not be happy about it, but they're not the ones who make franchising decisions. All the train tendering processes have been frozen while the Government checks through its West Coast dirty laundry, but one day the lucrative contracts will all be back and First will be jostling with the others to win them.

The problem for investors, however, is this: for First, the trains aren't the only problem. In fact, over the past few years they've been the least of its worries.

Since ex-London Underground boss Tim O'Toole was bought in to head up First in 2010, he has had to preside over a series of bad news. First there was a warning that falling margins in the US yellow school bus business would hit profits, then came the admission of far too many empty seats on its massive UK bus business. Austerity Britain meant some of its Northern customers couldn't afford the bus, First said. And with two-thirds of its UK bus passenger revenues generated in the North and Scotland, that meant lower profitability – wiping an expected 14 per cent off 2013 earnings.

First's idea of First aid to fix the problem is to accelerate sales of bus businesses that bring in £100m of revenues. Operations in north Devon, King's Lynn and London have already gone.

Yet in the midst of the sell-off – which industry whispers suggest has led to assets going cheap – First has stuck to its dividend-paying policy. And that, too, is worrying analysts. The City's transport men (they inevitably are all men) took their axe to the stock this week. Panmure Gordon's Gert Zonneveld kept his "hold" rating on the stock – but cut his target price to 230p. HSBC downgraded it from neutral to underweight, with its target price cut from 235p to 180p.

UBS reckons the share fall went too far and upgraded its FirstGroup rating from "sell" to "neutral" – but sliced £85m off its forecasts for the transport operator's net cash generation in 2013 and said First needs to raise its investment to improve cash generation and long-term profitability.

But the darkest warning from UBS covered the increased risk to First's dividend. Round about now, City short-termism means that shareholder payout is one of the few bright points surrounding the people-moving company. But without the West Coast bonanza, it could be cut – shares would plunge as a result. Sell 'em before they do.

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