Last train to easy profits

Railtrack has beaten many predictions, but the express may have reached the end of the line
Railtrack has proved a bonanza for investors. Since their flotation in May, the shares have soared from an offer price of 380p to a current 584.5p - a 150 per cent increase. Shareholders, already guaranteed an 18 per cent return through a special privatisation dividend and the part- paid nature of the issue, were laughing.

Perhaps there is a lesson in this for Labour; after all, Labour discontent and murmured threats of renationalisation seemed to contribute to the difficulties of selling Railtrack in the first place, and thus to an unreasonably low price. So Labour has few grounds for complaining that the company was sold on the cheap, when its own tactics contributed to the knock-down price.

Whatever the reasons behind the rise, and while Railtrack investors congratulate themselves on their prescience, there must be doubts now about how much longer this ride can last.

There are good omens. Unlike some other privatisation candidates, Railtrack had already operated for two years under the current regulatory regime, overseen by Rail Regulator John Swift QC, before it was launched into the public eye.

To date, Mr Swift's approach has consisted of a gentle laissez-faire. That may be changing, however. Last month, he sent a strongly-worded letter to the company, saying that evidence it had underspent by up to 25 per cent on its annual maintenance was "wholly unacceptable". It is a phrase previously unthinkable from the gentlemanly Mr Swift. Railtrack claimed it had failed to meet its promises because of disruption from the constant reorganisations forced upon it.

The total sum that is under dispute amounts to pounds 333m. Mr Swift may be forced to show his teeth, in which case, the investment outlook for Railtrack may alter substantially.

His presence is a necessary curb of Railtrack's effective monopoly control of the railway lines over which the train operating companies (TOCs) run. As in all monopolies, the threat is that Railtrack could raise its access charges to the rail network to unfair levels. The present regime is fairly relaxed, allowingRailtrack to increase charges by inflation minus 2 per cent. Although a tight framework, it offers a high degree of stability.

The return of a publicly quoted rail sector may seem like a romantic whiff from the first golden age of rail, in the early Victorian era. Alongside Railtrack, there are other quoted companies, notably Prism and Stagecoach, as well as beneficiaries of railtrack infrastructure maintenance, such as Jarvis, whose fortunes depend on rail travel and freight. But a warning to investors: while many made their fortunes on the Victorian railways, stocks were notorious for their boom and bust tendencies.

Such an outcome is unlikely for Railtrack, however, because it has no competition and is protected from the vagaries affecting its clients - the TOCs - by strict contractual agreements. The key issue for future profits seems to be costs. Here, there is more room for manoeuvre, although it is unlikely to be the usual job-cutting bonanza seen at the other privatised utilities.The company was designed, as a spokesman put it, as a "lean machine", so job cuts will be, if anything, only a small proportion of any future savings. More fruitful is the heavy capital expenditure programme to maintain and upgrade the 22,000 miles of railway lines it manages.

The expenditure is broken down into two categories by Railtrack: on-going asset maintenance, which costs a hefty pounds 600m; and a further pounds 740m or so on "day-to-day" maintenance. At the first half-stage, announced in November, operating costs, however, had risen slightly to pounds 1,035m from pounds 988m. Nevertheless, there was a strong overall rise in profit after tax to pounds 145m from pounds 111m, helped along by a rise in sales to pounds 1,204m from pounds 1,139m.

A reduction in costs will come, but it looks as if the recently knighted part-time chairman Sir Bob Horton will have to chisel them away, rather than gouge them out.

Since Railtrack's controversial flotation, the bogey of what a Labour government may do has receded. The most likely outcome, if Labour is elected, seems to be some trimming of the regulatory framework. But as this is tied up in complex contractual obligations, it would take the Department of Transport many moons to unravel it - an unlikely priority for Tony Blair's first Cabinet. Rather, Labour will probably let sleeping dogs lie.

Meanwhile, the shares have more or less caught up in comparison to other privatisations. On a forward price-earnings ratio of 11.9 for 1997, the shares are in line with many other utilities. The gross yield of 3.7 per cent may be attractive and, at least operationally, there should be relatively little risk. And the general rejuvenation of public transport can only be good for the company.

But at current levels, Railtrack must be close to hitting the buffers. The shares are now ripe for some profit taking, and the prospect of a possible Labour government can only flush out the sellers.


Share price 584.5p

Prospective p/e 11.9*

Gross dividend yield 3.7%

Year to 31 March 1995 1996 1997* 1998*

Turnover (pounds m) 2,275 2,300 2,361 2,409

Pre-tax profits (pounds m) 189.0 190.0 289.0 314.0 Earnings p/s (p) 20.2 42.8 48.8 53.2 Dividend p/s (p) n/a 13.8 22.1 23.6

*BZW Research forecasts