-- 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 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.
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.
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
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
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.
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,
-- 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.
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
-- 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
-- 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,
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