National Express Group PLC is one of the leading transport companies in the UK. The company operates buses, coaches and trains in the UK, US and Spain. This report analyses the business and financial performance of the group in the year ended 31st December 2009.
The year 2009 was a year of transformation and consolidation for the National Express Group. On one hand, the company was facing tougher market conditions due to recession and unemployment which impacted the number of passenger journeys. There were also questions about its ability and willingness to keep on operating loss making rail franchises in view of the declining passenger journeys. On the other hand, there were serious question marks about the survival of the company as lower profitability meant that the company was close to breaching lending covenants. On top of that, the management of the company had to deal with few unsuccessful bidders also.
The report reviews the business and financial performance of the company in 2009. The report analyses the challenges and risks being faced by the company. The financial performance is analysed with the help of five sets of financial ratios - profitability, returns, gearing, liquidity and efficiency.
The recurrent theme in 2009 was to consolidate the company by focusing on debt reduction and cash preservation. The report also reviews the steps taken by the company to improve the financial strength by focusing on reducing debt in 2009. Cash is important for survival of a business and the National Express Group knows it well now after the difficulties faced by it in 2009. The cash flow statement of the group is also analysed to understand the drivers behind cash generation in 2009.
National Express Group
Business Profile
National Express Group is a major transport company with presence in the UK, North America and Spain. The company runs buses, coaches and trains services and employees more than 41,000 employees worldwide (About Us). Passengers make more than 800 million journeys on company's services every year (About Us). The annual turnover of the company in the year ended 31st December 2009 was £2,711 million (Annual Report 2009, 2010, p. 56). National Express Group is listed on the London Stock Exchange with a market capitalisation of £1.16 billion (Market capitalisation, 2010).
History
The company started as a state-owned National Bus Company in 1968 to provide bus services across the UK (History). It started offering express coach services in 1972. The National Express Group was listed on the London Stock Exchange in 1992 and since then it has grown rapidly by acquiring companies (History). The company entered the UK rail market in 1996 (History). It entered the US and Spanish markets in 1998 and 2005 respectively by acquiring local companies (History).
Operations
UK.
National Express' bus service is the market leader in the UK outside the London bus market (About Us). The company is the largest operator of scheduled coach services in the UK. It also operates two rail franchises in the UK - c2c and National Express East Anglia services. However, the company will exit the rail franchises business in 2011 (Annual Report 2009, 2010, p. 05). The company has already handed back one rail franchise to the government in 2009 because of lower passenger journeys and higher losses. The company also operates the Midland Metro light rail service.
North America
The group operates yellow school buses in the US and Canada. It operates in 29 states in the US and 2 provinces in Canada with more than 1 million students using its services every day (About Us).
Spain
The group is the largest private bus and coach operator in Spain (Annual Report 2009, 2010, p. 15). The group operates ALSA branded services in Spain.
The graph 1 below shows the breakup of 2009 revenues according to the main geographic locations. UK is by far the biggest market for the company. Among the UK operations, the rail division was the biggest contributor to revenues. However, approximately 45% of group's normalised operating profits were generated in Spain in the year ended 31st December 2009 (Annual Report 2009, 2010, p. 03).
Graph 1
(Source: Annual Report 2009, 2010)
Major challenges and risks
Economy
According to the Chairman's Review in the Annual Report, the state of the economy is a major concern for any transport business (Annual Report 2009, 2010, p. 8). The decline in the GDP in the UK and Spain in 2009 resulted in lower discretionary and business travel in 2009 (Annual Report 2009, 2010, p. 8). This impacted the long distance coach and rail divisions of the company. The prospects of global economy does not look great and new austerity measures announced by various governments will most likely keep economic growth at lower levels.
Unemployment
The high unemployment following the latest financial crisis has resulted in lower number of journeys on company's buses, coaches and trains. In the UK bus division of the company, the rising unemployment in 2009 led to a 3% reduction in passenger journeys (Annual Report 2009, 2010, p. 19). Similar falls were recorded in the UK coach division. The even higher unemployment rates in Spain and recently announced austerity measures by the Spanish government will cause further pressures on company's revenues.
Fuel prices
Fuel costs constitute a significant proportion of the group's costs. The group cannot pass on the increases in fuel prices immediately because of contractual agreements and hence any increases in fuel prices will significantly affect its profitability.
Financial risks
The group is exposed to changes in the interest rates. Also, the group has to maintain banking covenants because of its debt. Any significant deterioration in its profitability, similar to the ones in 2009, may lead to breach of lending covenants.
Five year review
The table 1 shows the key financials over the last five years. The company's revenues increased every year till 2008 but declined marginally in the year ended 31st December 2009 due to tougher economic climate.
Table 1: 5-year summary of key financials
(Source: Annual Report 2009, 2010, p. 134)
The swings in profit before tax were sharp especially during the last two years. The profits before tax increased in 2006 and 2007 before declining in 2008. The group suffered losses before tax in 2009 due to the exceptional costs associated with the rail franchises and restructuring costs. The graph 2 shows the five years revenues and profit before tax.
Graph 2: 5-years revenues and profits
The earnings per share increased from 2006 to 2008 but the company suffered losses per share in 2009. The pattern in dividend per share was quite different from the pattern in the earnings per share. The company paid out a dividend of 32 pence per share in 2005 despite reporting a loss of 1.0 pence per share. This is because the earnings per share include many intangible expenses which do not impact the cash generating ability of company's operations. The cash generating ability of the business is better reflected in the normalised earnings per share which exclude amortisation of goodwill and intangibles, exceptional profit and loss on sale of non-current assets and exceptional items (Annual Report 2009, 2010, p. 135). The dividends paid out each year were less than the normalised earnings per share. The graph 3 shows the earnings and dividends per share over the last five years.
Graph 3: 5-years earnings and dividends
The company reduced its dividend in 2008 in spite of increase in profits due to the deteriorating economic conditions and fears about its high debts. The company did not pay any dividends for the year 2009 as it conserved cash to reduce debt and enhance its ability to meet lending covenants.
Share price review
The graph 4 below shows the relative movements in the FTSE 350 Index (^FTLC) and the share price of the National Express Group (NEX.L) over the last five years. The graph can be divided into three main sections. First section lasts till the middle of 2006. The group's share price fell as compared to a rise in the FTSE 350 Index.
Graph 4: 5-year change in the FTSE 350 Index and share price of the National Express Group
(Source: 5-years share price graph)
The second section of the graph is from the third quarter of 2006 till the end of 2007. The expectations about National Express' future earnings improved when the group reported its 2006 interim results in September 2006. The interim normalised operating profits rose from £58.1m in 2005 to £67.2m in 2006 (Wright, 2006). The group also announced the end of loss making UK end of Eurostar services which further buoyed the market and its share price rose by 22.5 pence on the day of the announcement (Wright, 2006).
The share price continued to increase till the end of 2007. In 2007, the share price of National Express which was almost down by 15% in the first half of 2006 increased to about 40% over the price at the beginning of 2006. The company's profits increased by 43% in 2007. This was driven by the higher growth in rail revenues and profits as commuters shifted to rail transportation due to higher fuel costs, congestion charges and slow-moving traffic (Vermeulen, 2008).
However, the enthusiasm about the National Express' future was short lived as can be seen in the third section of the graph which starts from the beginning of 2008. The share price has fallen dramatically from 2008 due to a number of reasons and events. The share price started to decline in 2008 when fear arose about the negative impact of softening economy on the number of passengers. The fall in the share price accelerated with the precipitation of global financial crisis in September 2008. When Stagecoach, a rival bus and train operator in the UK, announced profit warnings in its rail division, all hope of robust performance by the transport sector was lost as investors realised that large job cut announcements by financial firms in the City will have a severe impact on revenues in the rail division of the National Express Group (Elder and Hume, 2008). This confirmed the impact of economy and unemployment on the prospects of a transport company like the National Express Group.
The fall in the share price of the National Express Group was even steeper than its peer companies in the transport in the last two years as seen in the graph 5 below. Stagecoach provides bus and rail services in the UK.
Graph 5: 2-years movements in the share prices of the National Express Group and Stagecoach
(Source: 2-years share price graph)
The National Express Group was highly geared before the onset of the financial crisis as the company grew rapidly by acquiring companies in the UK and abroad (Annual Report 2009, 2010, p. 9). The sharp drop in the profitability due to the slowing economy put serious question marks on the ability of the company to meet its lending covenants and debt repayments. Markets were concerned that the company might be required to raise a significant amount of equity to reduce debt and ensure its survival (Elder and Hume, 2009). The survival concerns were further aggravated by the issues surrounding the East Coast franchise, one of the key rail franchises operated by the group.
The share price recovered in the second half of 2009 on back of reported bids for the company but again fell down when the acquisition of the company did not materialise. The failure of acquisition and successful announcement of a £360m rights issue at 70 percent discount led to a sharp fall in the share price in the last quarter of 2009 (Plimmer, 2009). Since then the share price has stabilised.
Overall, the company had a roller coaster year in 2009. The negative news and concerns about the survival of the company outweighed the expectations of being acquired at a premium. The failure to sell the company to a bidder and a rights issue resulted in sharp drop in the share price of the National Express Group in 2009.
Analysis of the financial performance
The financial performance of the National Express Group in the last two years is analysed with the help of financial ratios. Five categories of financial ratios - profitability, return, gearing, liquidity and efficiency - are analysed.
Profitability ratios
Appendix I shows the profitability ratios of the company over the last two years. The revenues declined marginally in 2009 due to poor economic conditions. Revenues of transport companies are strongly linked to the state of economy as higher unemployment leads to lower business and discretionary earnings.
The main reason behind the significant fall in operating profits before amortisation, impairment and exceptional costs was the sharp drop in the operating profits of the UK rail division from £80m in 2008 to only £12m in 2009 (Annual Report 2009, 2010, p. 72). The rail division had high fixed operating costs which are difficult to reduce in the short term and drop in passenger numbers severely impacted the profitability of the division in 2009. The ratio of operating profit before amortisation and exceptional charges to sales declined from 9.2% in 2008 to 5.9% in 2009.
The profitability of the group was further significantly impacted by the exceptional charges which increased from £30m in 2008 to £100m in 2009 (Annual Report 2009, 2010, p. 56). This jump in the exceptional costs was related mostly to the termination of the National Express East Coast franchise as the group paid an onerous contract charge and performance bond of £21m and £31m respectively (Annual Report 2009, 2010, p. 73). These exceptional costs along with losses from the company's share of income from its joint ventures turned the 2008 profit before tax of £110m into a loss of £84m in 2009.
The company received net tax credits in both 2008 and 2009 which reduced the post tax losses in 2009. Overall, the profitability of the company took a sharp beating in 2009 due to both poor economic conditions and high exceptional charges.
Return ratios
Appendix II shows the return ratios of the company over the last two years. The return on equity (Profit after tax / shareholders' equity) declined from a healthy 20.4% in 2008 to -6.3% in 2009. This was due to two reasons. Firstly, the net profits of 2008 turned into a net loss in 2009. It decreased the numerator in the return on equity ratio. Secondly, the shareholders' equity increased significantly in 2009 in spite of net losses due to a rights issue of £355m (Annual Report 2009, 2010, p. 108).
Return on capital employed is calculated by the following formula
Return on capital employed = Operating profits / (Total assets - Current assets)
The return on capital employed measures the return on long-term assets as it excludes the current assets. The return on capital employed was 0% in 2009 because the group had a net operating loss of £0.6m. The 0% return on long-term assets does not bode well for the long-term future of a business.
Gearing ratios
Appendix III shows the gearing ratios of the company over the last two years. The net debt of the company is calculated as per the following formula
Net debt = Non-current debt + Current debt - Cash and cash equivalents
The net debt to equity ratio of the company reduced from very high 201% in 2008 to a manageable 78% in 2009. This was due to the reduction in net debt and increase in the shareholders' equity.
The year 2009 was a year of financial restructuring for the National Express Group. As seen previously, the share price of the company took a severe beating due to high fears about breach of banking covenants and inability of the company to meet loan repayments in 2011. The company was close to breaching its gearing covenants in 2008 (Annual Report 2009, 2010, p. 23). The company focused on reducing its net debt. The net debt was reduced by £522m in 2009 due to a number of financial activities. Firstly, the company raised £358m from its shareholders in a rights issue (Annual Report 2009, 2010, p. 23). This was used to retire debt. Secondly, the group generated £164m internally (Annual Report 2009, 2010, p. 23). The internal cash was generated from improvements in the working capital, eliminating dividends and reducing net capital expenditure. The cash generation ability of the company is reviewed in a later section on the analysis of the cash flow statement.
The company also replaced the loans due in 2011 with a new and longer-term facility that further reduced the survival pressure and gave more confidence to both investors and users of its services.
The interest cover ratio (Operating profit / Interest expense) of the company declined to 2.3 in 2009 due to drop in the operating profits. The exceptional items and non-cash items like amortisation of goodwill and impairment are excluded from the operating profit used in calculating the interest cover to access the interest cover on the basis of on-going and cash generating ability of the business. The interest expense declined in 2009 and is expected to decline sharply in 2010 due to significantly lower borrowings as a result of the financial restructuring done in 2009.
Liquidity ratios
Liquidity ratios are concerned with the ability to meet short-term debts (McLaney, 2009, p. 67). Appendix IV shows the liquidity ratios of the company over the last two years. The current ratio (current assets / current liabilities) declined sharply from 0.60 in 2008 to 0.41 in 2009. This was due to both decline in the current assets and increase in the current liabilities in 2009. The current assets declined in 2009 due to reduction in the trade receivables as the company focused on releasing more cash from its working capital. Also, the fact that one of the rail franchises was handed back to the government helped in reducing the trade receivables.
The decline in the current ratio means that lower amount of cash is tied up in the working capital and reaffirms the company's focus on preserving cash. On the other hand, it also raises concerns for creditors as the significantly less than 1 current ratio means that the company will not be able to meet its current liabilities from its current assets alone.
The quick ratio is a more conservative version of the current ratio as it excludes inventory from the current assets. The quick ratio compares the current assets that can be easily and quickly converted into cash to the current liabilities (Seidman, 2004, p. 76).
Quick ratio = (Current assets - Inventory) / Current liabilities
The quick ratio was not much different from the current ratio because of the lower amount of inventories in both years. This is because of the nature of the business of the National Express Group.
Efficiency ratios
Appendix V shows the efficiency ratios of the company over the last two years. The asset turnover ratio (Sales / Total assets) of the company increased in 2009 mainly due to the significant decline in the total assets. The higher asset turnover ratio means that the management was able to generate higher sales per unit of assets in 2009.
The amount of inventory was very low in both years due to the nature of the business. Hence, inventory turnover ratio is not of significance and not included in this analysis. The debtor days declined by about 8 days as the company focused on reducing cash tied up in the working capital. The creditor days also declined by 5 in 2009 due to sale of some businesses by the company. Overall, the working cycle days declined by 3 (8-5) in 2009 which resulted in lower working capital. This shows the efficiency of the management in releasing cash tied up in the business.
The ratio analysis over the last two years highlighted two main issues. Firstly, the decline in the profitability and returns in 2009 due to falling economy and higher exceptional charges. The company faced tough economic climate which impacted the number of journeys and profitability. Secondly, it showed the focus of the management on improving the capital structure and financial strength of the business. This was done to ensure the long-term survival of the business and was achieved by reducing debt by issuing more equity and reducing working capital by improving the efficiency of the business.
Analysis of the cash flow statement
Appendix VI shows key items in the cash flow statement of the group. The net cash inflows were £3.3m in 2009 as compared to net cash outflows of £60.3m in 2008. The main drivers behind the significant change in cash flows were the investing and financing cash flows as the difference between net cash flows from operations in two years was only £7.4m.
The net cash used in investing activities declined to only £6.1m as the company reduced the amount spent on purchasing new assets and increased the sale of existing assets and businesses. This saved the company £87.8m in 2009. However, lower investment in new equipment and businesses may slow down growth in the future revenues.
Even though the net cash outflows from financing increased by £31.6m in 2009, it was the distribution within the financing activities that was important. The company raised cash by issuing additional equity in a rights issue. The proceeds of the equity were then used to retire debt. The company also saved £44.3m by eliminating the dividend in 2009.
The above analysis of the cash flow statement confirmed the company's focus on improving the financial strength of the company by reducing debt.
Conclusion
The year 2009 was a year of restructuring and consolidation for the National Express Group. The company faced tough economic climate which had a negative impact on the business. With high fixed costs, the company's profitability took a severe beating along with negative returns in 2009. There were serious questions about the company's ability to meet its lending covenants and repay loans.
As a result, the focus of National Express Group's management was on restructuring the financials of the company. The company raised £358 million in rights issue to reduce high debt to a manageable level. It further issued new loan notes with a longer term to replace the loan due in 2011 to ease investors' concern about loan repayments. On the operational side, the company's focus was to increase internal cash generation by reducing investments in assets and increasing sale of businesses.
Overall, the company had a roller coaster year in 2009. The failure to sell the company to a bidder and a rights issue resulted in sharp drop in the share price of the National Express Group in 2009. However, the rights issue, lower debt with a longer term means that the company ended 2009 in a much stronger financial strength. The profitability of the company may still be impacted by the slower growth in economy in the near future but the financial restructuring steps taken by the company mean that it has the financial strength to deal with it.
