TEXT-S&P affirms FirstGroup 'BBB-/A-3' ratings, outlook negative

Tue Oct 16, 2012 9:57am EDT

Overview
     -- On Oct. 3, 2012, the U.K. Department for Transport cancelled the 
competition for the West Coast rail franchise, overturning its decision to 
award the franchise to FirstGroup PLC.
     -- This followed FirstGroup's interim update, which confirmed that the 
group's bus earnings will likely experience a moderate decline in financial 
year 2013, and the payment of a dividend, including minority dividend 
payments, of about GBP135 million in 2013.
     -- We have revised our analytical consolidation and base-case scenario 
for FirstGroup and are affirming our 'BBB-/A-3' corporate credit ratings on 
the group.
     -- The negative outlook reflects our view that credit metrics will weaken 
in 2013 and may not recover to levels that we consider commensurate with the 
rating in the following year.

Rating Action
On Oct. 16, 2012, Standard & Poor's Ratings Services affirmed its 'BBB-' 
long-term and 'A-3' short-term corporate credit ratings on U.K.-based 
transport operator FirstGroup PLC. The outlook is negative.

Rationale
We are affirming the ratings despite the cancellation of the competition for 
the West Coast rail franchise in the U.K., which had previously been awarded 
to FirstGroup. The affirmation reflects our view that although we anticipate 
FirstGroup's credit metrics will be below our expectations for the rating in 
the financial year ending March 31, 2013, we believe they will recover 
thereafter. However, we expect that credit metrics will be below that level in 
financial year 2013.

Following a review of U.K. rail franchise arrangements, we have amended our 
analytical scope for FirstGroup. We are now excluding FirstGroup's U.K. rail 
franchises from our analytical consolidation, and incorporating them in our 
analysis as investments. This is because, in our view, FirstGroup's train 
operating companies are ring-fenced from the rest of the group. (For further 
detail, see "The Impact Of U.K. Rail Franchise Reforms And Our Analytical 
Treatment Of Train Operating Companies," published earlier today on the Global 
Credit Portal.)

Accordingly, we deconsolidate U.K. rail operations from FirstGroup's reported 
financials, and capture the dividends received from these investments in 
adjusted funds from operations (FFO). We also add to debt any undrawn 
subordinated loan facilities that the group provides its train operating 
companies. This is because, in our view, these commitments are akin to 
financial guarantees. On that basis, FirstGroup's adjusted FFO to debt was 21% 
on March 31, 2012 (it would be 21.6% excluding our adjustment to debt for 
contingent liabilities related to rail).

Our ratings on FirstGroup reflect our assessment of its business risk profile 
as "intermediate" and of its financial risk profile as "significant." Despite 
continued weak economic conditions and high fuel prices, we anticipate that 
FirstGroup will be able to restore the profitability of its core U.K. and U.S. 
bus operations. We anticipate that the group will continue to benefit from its 
diversified portfolio of mainly stable businesses, its cost-control 
initiatives, and its fuel hedging strategy. 

We have updated our base-case scenario to reflect the group's latest trading 
update and the cancellation of the competition for the West Coast rail 
franchise. We have also incorporated our macroeconomic forecasts for 
FirstGroup's core markets, which have recently been revised downward. We 
forecast that, in the U.K., GDP will decline by 0.4% in 2012 and recover the 
following year, with 1% growth. In the U.S., we forecast GDP growth in the 
range of 2% a year over the period (see "The Eurozone's New 
Recession--Confirmed", Sept. 25, 2012, and "U.S. Economic Forecast: He's 
Buying A Stairway To Heaven", Sept. 21, 2012, available on the Global Credit 
Portal).

Under our base-case scenario, we forecast that FirstGroup's adjusted revenues 
(excluding U.K. rail) will decline by about 2.6% in the financial year ending 
March 31, 2013, compared with the previous year, and that it will stabilize 
the following year. We also anticipate that adjusted EBITDA margin will be 
12.2%, compared with 13.1% the previous year, and that it will increase 
moderately the following year. 

Variation in the profitability margin reflects our expectation that 
profitability at the group's U.S.-based First Student division will improve in 
2013, on the back of measures to strengthen the operating model and increase 
the number of contract renewals. It also reflects our anticipation that 
FirstGroup's U.K. bus business' profitability will weaken in 2013, and 
gradually recover thereafter as less-profitable bus assets are sold. Our 
base-case scenario incorporates a slower implementation of the disposal 
program than that forecast by the management team; we expect to see proceeds 
of GBP50 million in 2013 and the remainder of the disposal program the following
year. We understand that in the year to date, limited progress has been 
achieved in terms of disposals, and the management team indicated in its 
trading update that there could be delays in implementing the program.

Our base-case scenario incorporates FirstGroup's stated dividend policy, which 
involves the payment of a dividend of about GBP135 million (including minority 
dividend payments) in 2013. Because the group has given no guidance on its 
dividend policy from 2014, we have not assumed any dividends after 2013.

We forecast that over the next two years, reported net debt will remain 
broadly stable, at about GBP1.9 billion, while adjusted debt will decline as 
U.K. rail franchises reach their term. We also forecast that adjusted FFO will 
fall, reflecting weaker earnings and our forecast decline in dividends from 
U.K. rail franchises. We anticipate that adjusted FFO to debt will be below 
what we see as commensurate with the rating, at about 20% in 2013, before 
improving the following year to close to 25%.

The negative outlook reflects the risk that FirstGroup's financial metrics may 
not recover sufficiently within the next two years. Although under our 
base-case scenario we forecast that adjusted FFO to debt will be about 23% in 
2014, which is below the 25% level that we see as commensurate with the 
rating, we take some comfort from FirstGroup's commitment to its 
investment-grade rating, which it has maintained since 2002, the group's 
stated focus on further leverage reduction, and management's ability to manage 
dividend policy and asset disposals.

Following its decision to cancel the West Coast award, the U.K. government 
ordered independent reviews to be undertaken urgently and halted all 
outstanding franchise competitions. We expect that this could delay the 
re-tendering timetable. FirstGroup could benefit from some of its rail 
contracts being extended to cover any delay. However, given that it is 
uncertain whether such extensions would be granted, for how long, and under 
what terms, we have not factored this into our base-case scenario. 

We understand that FirstGroup's strategy remains to bid for new rail 
franchises. Its intention is to maintain its current market share. New 
franchises would be beneficial to FFO, in our view. However, they will also 
result in an increase in adjusted debt as we capture in our debt adjustments 
the subordinated loans/guarantees provided by the group. The size of these 
instruments will depend, in part, on the riskiness of the bids, as assessed by 
the Department for Transport at the time of the franchise award. Any impact on 
the rating will depend on the relative weight of these two parameters.

Liquidity
The short-term rating is 'A-3'. We consider FirstGroup's liquidity to be 
"adequate" under our criteria. We estimate that sources of liquidity will 
cover uses by about 1.3x over the next 12 months.

We calculate liquidity sources for the 12 months to June 30, 2013, of 
approximately GBP1.1 billion, comprising:

     -- Unrestricted cash and cash equivalents of about GBP155 million, 
excluding ring-fenced cash balances.
     -- About GBP410 million of availability under a $1.25 billion revolving 
credit facility (RCF) due Dec. 9, 2015, and a fully available GBP75 million RCF 
due April 3, 2015.
     -- FFO (prior to Standard & Poor's adjustments, except for U.K. rail) of 
about GBP410 million.

We calculate liquidity uses for the same period of more than GBP800 million, 
comprising:

     -- Debt maturities of about GBP380 million.
     -- Capital expenditures (excluding U.K. rail) and dividends, including 
minority dividend payments, of about GBP430 million.

There are no credit rating triggers with liquidity implications in the 
existing loan documentation, and FirstGroup expects to remain compliant with 
its bank financial covenants during the next 12 months.

Outlook
The negative outlook reflects our view that FirstGroup's financial risk 
metrics will be below what we consider commensurate with the 'BBB-' rating in 
financial year 2013, and may not recover sufficiently in the following year.

We could lower the rating if FFO to debt were to deteriorate beyond our 
current expectations in the near term, or if it does not sustainably recover 
to about 25% thereafter. This could occur if the trading environment 
deteriorates, as a result of dividend policy, or because of debt-financed 
acquisitions that lead to a weakening of the group's credit profile. It could 
also occur, in our view, if the group takes on very large contingent 
liabilities associated with new rail franchises, although this will depend on 
the dividend stream generated by these franchises.

We could revise the outlook to stable if FFO to debt were to recover to at 
least 25%, which is the level that we consider commensurate with the 
'BBB-/A-3' ratings. This could occur if the group makes more-significant asset 
sales than we currently incorporate into our forecast and trading conditions 
improve, leading to a reduction in leverage.

Related Criteria And Research
Related Criteria
     -- Business Risk/Financial Risk Matrix Expanded, Sep. 18, 2012
     -- Short-Term/Long-Term Ratings Linkage Criteria For Corporate And 
Sovereign Issuers, May 15, 2012
     -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
     -- Principles Of Credit Ratings, Feb. 16, 2011
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
     -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
     -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008
     -- Parent/Subsidiary Links; General Principles; Subsidiaries/Joint 
Ventures/Nonrecourse Projects; Finance Subsidiaries; Rating Link to Parent, 
Oct. 28, 2004

Related Research
     -- The Impact Of U.K. Rail Franchise Reforms And Our Analytical Treatment 
Of Train Operating Companies, Oct. 16, 2012
     -- The Eurozone's New Recession--Confirmed, Sept. 25, 2012
     -- U.S. Economic Forecast: He's Buying A Stairway To Heaven, Sept. 21, 
2012

Ratings List
Ratings Affirmed

FirstGroup PLC
 Corporate Credit Rating                BBB-/Negative/A-3  
 Senior Unsecured                      BBB-               



Complete ratings information is available to subscribers of RatingsDirect on 
the Global Credit Portal at www.globalcreditportal.com. All ratings affected 
by this rating action can be found on Standard & Poor's public Web site at 
www.standardandpoors.com. Use the Ratings search box located in the left 
column.
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