It seems that the Southern Rail train strikes have been bad news for almost everyone involved, apart from the unions and Southern’s owner, Go-Ahead Group (LSE: GOG).
Indeed, Go-Ahead seems to be pulling through this period of rail turbulence relatively unscathed due to the unusual structure of its contract.
According to the company’s franchise agreement with the government, taxpayers pick up the tab for any refunds Southern is forced to issue for rail delays, and the company continues to receive cash just for running the franchise.
An unusual agreement
Govia Thameslink, which runs Southern and 65% owned Go-Ahead has a unique agreement with the government for its train franchise. Under the terms of the agreement Govia just runs the service and gives revenue directly to the Department for Transport. This means the firm doesn’t get fined when it cancels trains, and there’s no need for the group to have good relations with its workers as, at the end of the day it’s only the government that loses money if things don’t go to plan.
This highly unusual arrangement is one-of-a-kind, but it’s unclear who it actually benefits as it seems all parties lose out. According to Go-Ahead’s management, the rest of the group is subsidising Govia’s lossmaking operations and handed £222m from rail fees to the government during 2016.
With this being the case, Go-Ahead’s management might be praying for the government to nationalise the Southern franchise. If this scenario did unfold, Go-Ahead would be quids in. The disposal of the lossmaking business would help improve overall group profits and margins. Last week Go-Ahead issued a trading statement warning that due to industrial action, overall group revenue would come in lower than expected for the year.
Specifically, the company warned: “Our full year expectations for the rail division are slightly below our previous estimates due to higher-than-expected costs associated with the GTR franchise.”
City analysts are expecting the company to report a 7% fall in earnings per share for the financial year ending 30 June 2017. Revenue for the period is projected to tick higher by around £100m or 3%. The shares currently trade at a forward P/E of 10.3 and support a dividend yield of 4.7%.
Conclusion
All in all, it looks as if Go-Ahead might actually benefit from the confiscation of the Southern franchise. In the near term, the company’s revenue might take a hit, but based on statements from the company the Govia business is loss-making and without it overall group profits will improve.
That being said, the one unknown is how Go-Ahead’s balance sheet would hold up following the loss of the Southern franchise. At the beginning of July, Go-Ahead reported adjusted net debt of £239m, 1.4 times adjusted EBITDA, which doesn’t seem too onerous. Indeed, if profits rise following the loss of Southern, this debt might become more manageable.
Will the Southern Rail strikes bankrupt owner Go-Ahead? They might just have the opposite effect.