Should you invest in ... private railway companies?
Wednesday 23 June 1999
There is proof.Hans Georgeson of Barclays Stockbrokers says: "Railtrack's recent report showed volume growth in passenger miles of 8 per cent and the figure for freight was 18 per cent, so clearly there is growth in the sector."
But there is a feeling life will be toughere. David Thornton, head of UK Equities at Witan Investment Trust, says: "The growth has been recognised and a lot of the shares rerated. The key issue is whether the operating companies can get extended franchises to give them the opportunity to build capacity growth into the network."
Jenny Campbell adds: "The most important factor in the railway business is that it continues to make good growth in passenger numbers. Rail companies are getting a reducing level of subsidy from the government over the period of their franchises, but they are allowed to keep the revenue from passenger fares. Obviously, it is a cyclical business. If the economy turns down, fewer people use the railway, but it is a case of so far, so good."
The major constituent of the sector is the provider of the railway infrastructure, Railtrack, which had a spectacular start to its stock market career, partly because of the value of its land portfolio. Jenny Campbell says: "Railtrack peaked at pounds 17, but is back at around pounds 13. It is political. Politicians love to play the line that with profits of pounds 400m Railtrack is making too much money. The company adopts a pragmatic approach and realises it has to do something with the money, so it is talking about spending pounds 27bn over the next few years improving the service."
So a key question is whether Railtrack can return to its former heights, for which it will need continued political support. Jenny Campbell adds: "It will be offered the first contract to run the subterranean lines of the Underground, an indication that it's in political favour."
Hans Georgeson says: "We have put a price target of pounds 16 on Railtrack. You have to see it as almost two different companies because the public perspective, that of the frustrated commuters, is totally divorced from the view that the investor has of the company. From the investor's point of view, the Government has to deliver on its cornerstone transport policy and for that it needs Railtrack to be functioning effectively."
David Thornton says: "You have to decide how you look at Railtrack. If you look at it as a utility business that will be very strongly regulated then it is not a terribly attractive proposition, But if you hold the view that public transport is a growth area with passenger numbers increasing, having been declining for several years, then it is much more positive."
Hans Georgeson agrees. "The key question is whether Railtrack is seen as a utility stock or a growth stock. If it is valued as a utility , it is worth pounds 10 to pounds 12 per share, but if it is a growth stock, it is more likely to be valued at somewhere around pounds 17 to pounds 20. One way of ensuring it is seen as a growth stock, is by allowing it to gear into the growth in passenger volumes and to encourage it to grow its passenger base, That would characterise it as a growth company and the market puts a much higher rating on that."
David Thornton is clear: "I tend to the growth view which was controversial when we first starting buying. I still think there is enough growth there to interest investors, assuming the business can be developed along growth lines."
Hans Georgeson adds: "The new deal on the Underground is good news from the investor's point of view. The Government has to allow Railtrack sufficient return on capital to enable them to raise sufficient capital to fund the deal as they will have to go to the market to do this."
David Thornton says: "It has become intensely fashionable to criticise Railtrack, its PR has been appalling and it is a very soft target, but its growth in volume has been impressive and encouraging. But at the end of the day, if the sector is going to be heavily regulated in a way that won't allow Railtrack to make large profits, the growth story will be much shorter-lived."
Hans Georgeson says: "In the late autumn we are expecting some sort of `rail summit', laying down the regulations governing Railtrack and the operating franchises from 2001. That is the most critical thing in the sector from the investor's perspective and, because of the position Railtrack has within the business, it should emerge from this with reasonably good terms."
There are possibilities for impressive growth amongst the operating companies, provided external factors can be made to work in their favour, David Thornton adds. "The operating companies have to take costs out then drive profits and passenger numbers. The better operators have driven volumes well, through simple things like actually collecting all the fares.
"But the key issue must be being able to lock into a longer-term business and the companies are trying to negotiate longer-term franchises in return for investing more. They have got to be given the opportunity to get a decent long-term return."
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