Go-Ahead Group - another high yield defensive

Monday, Oct 01 2012 by
GoAhead Group  another high yield defensive

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.  Insteadthey’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 proxies like sales, earnings and dividends.  This means buying shares when the earnings and dividend yields are high (and the sales yield too if you wanted to calculate that).

In Go-Ahead’s case, the dividend yield today is around 6%, largely unchanged from when I first bought into this company in February 2012.

While 6% is a long way from being the highest yield in the market, it is well above average, especially for a dividend which has a very good chance of being maintained and increased in the longer-term.

Although the high yield is far from the only reason I bought this company, the dividend is often one of the most reliable indicators of a low price, and a high yield is one of my core requirements.

Step 3: Be patient

If you’re buying shares and have even the slightest notion that you are going to sell within the next year, then you are not an investor – you are a trader.

The same thing applies if you are more concerned about the share price than you are about the underlying fundamentals of the business.  Investing is about investing in businesses, not pieces of paper or share price that bounce around on a screen all day long.

Personally, I like to look at equity investments as an extension of cash and bonds.  This is a way of viewing equities as something which Warren Buffett called the equity bond.

Since we cannot know what the share price of any company will be tomorrow, next week or next year, it make sense to look at equities as long-term investments.

In my case I like to imagine that I am buying an ‘equity-bond’ with a 5 year term.  So when I buy shares I think about whether I’d be happy to buy them if I had to own them for a fixed term of 5 years.

This means that I start thinking about whether the company will be around in 5 years.  Whether it will be bigger or smaller in 5 years, and what the dividend will be in 5 years.  Each of these questions has a massive influence on the sort of companies I’ll invest in.

It means that I look for companies that are virtually certain to still be around in 5 years, are very likely to be bigger, and are very likely to have paid a reliable and growing dividend throughout.

Of course, neither I nor anybody else knows how the future will pan out, which is why I like strong and stable companies.  Even though I cannot know what the future looks like, at least I’m less likely to be wildly wrong with a company like Go-Ahead.

One more useful feature of imagining a 5 year fixed holding period is that I don’t worry too much about what’s happening today, either with the company or the economy.  I know that today is just one tiny slice of the amount of time that I’m going to be holding my investments, and therefore should only make up a tiny slice of the importance.

So Go-Ahead fits my criteria for a strong, stable company that is very likely to grow over time.  I bought it at an attractive valuation and I intend to sell it as and when the valuation is no longer attractive.  The timing of this is entirely in the hands of Mr Market, but if it takes 5 years or more than that’s fine by me.  In the mean-time I will be patiently collecting my dividends.

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This article is for information and discussion purposes only and nothing in it should be construed as a recommendation to invest or otherwise. The value of an investment may fall and an investor may lose all their money. Any investments referred to in this article may not be suitable for all investors.  Investors should always seek advice from a qualified investment adviser.

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The Go-Ahead Group plc is a United Kingdom-based public transport operator, which provides services in the bus and rail sectors. The Company operates in three segments: regional bus, London bus and rail. The regional bus segment is engaged in the bus operations outside London. The London bus segment is engaged in the bus operations in London under control of Transport for London (TfL) and also rail replacement and other contracted services in London. The Company's rail segment, through an intermediate holding company, Govia Limited, is engaged in four rail franchises: Southern Railway Limited (Southern), London and Southeastern Railway Limited (Southeastern), London and Birmingham Railway Limited (London Midland) and Govia Thameslink Railway Limited (GTR). Its subsidiaries include Go-Ahead Holding Limited, Go North East Limited, Go Northern Limited, London General Transport Services Limited and London Central Bus Company Limited. more »

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6 Comments on this Article show/hide all

toddwenning 3rd Oct '12 1 of 6

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?


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.



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toddwenning 3rd Oct '12 2 of 6

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?



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UK Value Investor 3rd Oct '12 3 of 6

In reply to toddwenning, post #2

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.


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dbfromgb 3rd Oct '12 4 of 6

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

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emptyend 3rd Oct '12 5 of 6

In reply to dbfromgb, post #4

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.

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UK Value Investor 6th Nov '12 6 of 6

In reply to dbfromgb, post #4

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.


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About UK Value Investor

UK Value Investor

My name is John Kingham and I'm the editor of UK Value Investor, an investment newsletter for defensive and income-focused value investors. That means I write about buying large, successful companies with long track records of profitable dividend growth, and buying their shares at low valuations and with high yields. My website includes a unique stock screen and a model portfolio which is managed using a checklist-based investment strategy.  The goal of the strategy is to produce a portfolio which combines a high yield and good capital growth with low risk, and which is easy to maintain in just a few hours each month. more »


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