Go-Ahead Group - Another High Yield Defensive

1st Oct '12 by UK Value Investor

6 comments 6239 reads

I know that some of my best investment returns have come about not from some amazing insight into what the company was going to do, or what the economy was going to do. Instead, they’ve come from combining solid and stable companies, with an attractive starting valuation and a healthy dose of patience.

I think the best way to invest is to look for companies where their earnings power and underlying value is following a relatively stable upward trend. All you have to do then, more or less, is buy them when they’re cheap, and sell them when they’re dear (if only it were that simple).

Enter Go-Ahead Group

Go-Ahead is one of the largest public transport groups in the UK. They’re split fairly evenly between buses and trains, with over a million passengers a day travelling on their rail services and almost two million on the buses.

As a public transport company they’re fairly well insulated from economic ups and downs, as people have to get to work and travel around no matter what.

Step 1 – Find a company with a stable intrinsic value

You can see Go-Ahead’s results over the last decade below.

Even though Go-Ahead is a defensive company, its earnings have still been affected by this long recession. However, even though earnings show a boom and bust peak between 2006 and 2008, the general picture is one of relative stability with a long-term upward trend.

Sales are up, the dividend has been maintained and even in the depths of a recession, earnings are above where they were 10 years ago. I think the future for Go-Ahead is likely to be much the same – stability, profit, dividends, and some mild growth.

What does that have to do with intrinsic value? Although intrinsic value isn’t something which we can actually calculate, it is based on sales, profits, cash flows and dividends. If these things are broadly stable, predictable and dependable, then so is the company’s intrinsic value. This means that it will be easier to work out when the share price is high or low in relation to that intrinsic value.

Step 2: Buy when the price is low relative to value

Buying low means buying low relative to the intrinsic value. Since we cannot know the intrinsic value we have to use…

Unlock with Email

Unlock with Google

Already have an account?
Login here

toddwenning

3rd Oct '12

Hi John,

Interesting. Thanks for sharing your insights on Go-Ahead Group.

Given your interest in buying "equity bonds" with a five year term, have you considered simply buying Go-Ahead Group's 2017 bonds?

http://www.go-ahead.com/ir/debt_investors.aspx

I haven't been able to find the 2017 bond's YTM, but if it approximates the dividend yield, the bonds could be the less risky option.

Best,

Todd

Sorry, it looks like the 2017 bond has been bid up and the yield is about 3%. Not much value in the bond market these days. :)

Still, comparing a share's dividend yield with the yield on its longer-term bonds might be a good practice if your main objective is income generation.

An equity question, if I may -- what are the primary reasons behind the margin and ROCE erosion this year?

Best,

Todd

UK Value Investor

Hi Todd

I don't really look at bonds, so I'm no expert, but as you say they should be the safer option and if you want low risk more than high returns then I guess they're a good alternative to the volatile world of stocks, especially if you ignore the secondary bond market.

As for Go-Ahead's margin, I don't think there are any huge changes. Mostly it's due to lower rail margins, but it's more or less in line with the last few years. Really it seems to have dropped off since 2009 which is sort of what I'd expect given the economic backdrop.

John

dbfromgb

There is perhaps one thing you are not properly taking into account, and that is the effect of the goverment funding framework.

On the bus side a large chunk of of revenue (at least half) comes from goverment funding which has reduced dramatically in the last two years or so - especially reimbursement for concessionary passengers, Bus Services Operators Grant, and the availability of tendered and contract work.

On rail the future has some visibility in the short term, but the future is guided by the retendering process for the franchises.

Pretty much all the cost savings have been squeezed out of the bus industry now. Further service cuts risk damaging the network, and there is little room to put up prices further in the current environment. Wage pressures are growing (see for example strike at First Cymru this week), and other costs are rising faster than inflation (eg fuel. tyres and insurances).

So whilst the principle you mention has merit, you also need to factor in that the current operating environment is fundamentally different from a couple of years ago - at least on the bus side.

Hope this helps

emptyend

On rail the future has some visibility in the short term, but the future is guided by the retendering process for the franchises.

Pretty much all the cost savings have been squeezed out of the bus industry now. Further service cuts risk damaging the network, and there is little room to put up prices further in the current environment. Wage pressures are growing (see for example strike at First Cymru this week), and other costs are rising faster than inflation (eg fuel. tyres and insurances).

So whilst the principle you mention has merit, you also need to factor in that the current operating environment is fundamentally different from a couple of years ago - at least on the bus side.

All excellent points IMO.

At the start of the recession one could reasonably have thought public transport was a defensive bet (and of course it still is, at least in relative terms, being a cash business!). But there have been some big changes - and costs have been driven down as far as they can be (think Polish bus drivers etc).

The PSOG (Public Service Obligation Grant) money may also be under pressure - as local council subsidies undoubtedly already are!

The other factor on the rail side (and I haven't looked at the details!) is the extent to which they will be impacted by todays moratorium on new rail franchises.

One of the big risks with these apparently-stable, solid businesses is of some un-noticed external change that might cause a company's earnings to unexpectedly hit the buffers, so it is worth continuing to pay close attention to the business fundamentals - and not just the accounting numbers.

6th Nov '12

Sorry for the delayed reply dbfromgb and thanks for those points.

However, in their interim management statement of October 18th the company announced a goal of growing bus profits to £100 million, which stands in contrast to your (very good) points about their bus business.

This highlights an interesting point, which is that most of the time the future is not knowable.

Whether they hit that £100 million target or not is the point. The point is that, in my opinion, the future is too opaque to for there to be much value in looking closely at current business conditions. It's like flipping a coin. That's why my whole approach is based around looking at what happened in the last 10 years and what may happen in the next 10, and then trying to buy at a price which discounts the future quite aggressively.

So for me the current environment is at most perhaps 20% of my analysis, which I realise is quite different to how most people do it, but I think minimising the importance of the present is a major advantage over other investors.

The same thinking applies to the rail franchise problems we're currently seeing. What will the franchise environment look like in 5 or 10 years? I don't have the faintest idea, and neither does anybody else, and seeing as I'm quite likely to still be holding Go-Ahead in 5 or 10 years I can't possibly factor that sort of thing into my analysis other than to assume it's hopefully going to be fairly similar to what we have today. Of course that's probably going to be wrong as the environment may well have changed, bit it's no more wrong than any other assumption I could have guessed at.

John

Go-Ahead Group - another high yield defensive

Unlock the rest of this article with a 14 day trial

About the Author

UK Value Investor

6 comments

Unlock the metrics for all these stocks and more...

Unlock the metrics for all these stocks and more...