(The following statement was released by the rating agency)
1 - Fitch Ratings has downgraded the UK and North American-based bus and rail operator group FirstGroup plc's (FirstGroup) Long-term Issuer Default Rating (IDR) and senior unsecured rating to 'BBB-' from 'BBB'. The agency affirmed FirstGroup's Short-term IDR at 'F3'. The Outlook on the Long-term IDR is Stable.
The downgrades reflect lower earnings expectations. Additionally, adjusted leverage was slightly higher than anticipated at FYE12. As a result, FirstGroup's adjusted leverage remains too high for the previous rating.
The lower than expected profitability largely originates from FirstGroup's UK bus division (representing 31% of FY12 EBIT) which is experiencing lower revenue growth, reflecting weaker pricing power commencing in Q4FY12. Lower revenue growth is not expected to mitigate foreseeable cost increases as a result of the UK government's spending cuts to the sector, whereas the company expects to largely offset cost inflation items with planned cost efficiencies.
Although the UK bus division's margin may improve faster than currently guided by the company, this would be initially achieved by the disposal of underperforming activities including related assets such as bus depots. Whilst such proceeds could reduce net debt, the overall earnings level from ongoing operating bus activities is likely be lower than previously expected.
The Stable Outlook takes into consideration FirstGroup's other businesses which have performed largely as expected, notably the North American-based First Student's margin appears to have bottomed-out in H212 (this business represented 25% of FY12 EBIT). However, in the near term, Fitch does not expect First Student's margins and earnings to improve to pre-crisis levels.
FirstGroup has pre-qualified in all four new UK rail franchises that have come to the market. The agency therefore expects the company to remain a significant player in this market, but it is too early to judge the potential financial impact of any franchise wins or losses. Generally, Fitch views the contribution of the UK rail earnings (26% of FY12 EBIT) as a meaningful diversification to the company's bus operations.
Whilst Fitch considers FirstGroup's business profile as comfortably investment grade, a change in the company's capital structure targets or further trading disappointment that would result in sustained leverage, measured as lease-adjusted net debt (excluding restricted cash) to EBITDAR, above 3.5x would put pressure on the ratings. A positive rating action is not anticipated in the near term.
As of 31 March 2012, FirstGroup had GBP632m of unused committed bank facilities (mostly due in December 2015) and GBP164m of unrestricted cash, placing it in a comfortable liquidity position. Fitch anticipates marginally negative free cash flow in FY13 (pre-disposals and post-dividends). The company does not have material debt maturities in FY13 and has a GBP300m bond repayment due in April 2013 which can be comfortably met from its liquidity resources.
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