OREANDA-NEWS. Fitch Ratings has affirmed FirstGroup PLC's (FirstGroup) Long-term Issuer Default Rating (IDR) at 'BBB-', its Short-term IDR at 'F3' and its senior unsecured rating at 'BBB-'. The Outlook on the Long-term IDR is Stable.

The rating affirmation reflects FirstGroup's firmer operating performance in FYE15 (financial year end March) and consequent improvement in its credit metrics, which are now comfortably within Fitch's rating guidelines for a 'BBB-' credit. The ratings also reflect the company's business profile as a leading UK bus and rail operator with geographical diversification in North America.

KEY RATING DRIVERS

Strong Business Profile
FirstGroup's 'BBB-' rating reflects the company's strong business profile compared with its peers. FirstGroup is the largest company by revenue of the three UK land transport companies rated by Fitch. The company generated revenues of approximately GBP6.1bn in FY15.

FirstGroup operates within a well-diversified, albeit competitive and fragmented, selection of transport sectors including school bus, transit, intercity coach and local bus services in the UK and North America. This diversity provides the company with a strong mix of consistent contract-based earnings, such as in US Student and UK rail, which can help counter its more cyclical operations, such as intercity coach services, during difficult economic conditions.

Improved FY15 Performance
FirstGroup's operating performance in FY15 was better than Fitch's expectations, driven by 13% growth in operating profit (EBITA) to GBP304m and an increase in the group's operating margin of 100bp to 5%. This improvement was mainly driven by higher operating profits in the US Student, UK bus and UK rail divisions, partially offset by decline in the North American inter-city coach business, Greyhound. FirstGroup's financial profile was also improved by the reduction of around GBP800m of gross debt since the rights issue in FY13 and the suspension of dividend payments since FYE14. While the company has not benefitted from lower fuel prices, its fuel hedging policy is in line with other UK peers and hence is not a differentiating factor.

Metrics Comfortably within Guidelines
FirstGroup's FYE15 metrics of funds from operations (FFO) adjusted net leverage of 3.1x and FFO fixed charge cover of 3.9x were comfortably within the 'BBB-' rating guidelines. We expect leverage to remain within the 3.0x-3.5x range and interest cover to remain above 3.5x over the FYE16-FYE19 period. This is based on the assumption of continued gradual improvement in the UK bus, US school bus and transit divisions. Fitch also expects FCF to be neutral-to-negative with capital expenditure comparable to current levels and our assumption of dividend reinstatement in FYE17.

First Student's Good Performance
The rating affirmation is underpinned by an improvement in the First Student business. Revenue increased only 1% year-on-year while operating profit increased 23%. Operating margin rose to 7.8% from 6.4% due to firmer pricing on new contracts (1/3 of the portfolio was re-tendered in 2014), a recovery of the lost operating days from poor weather in FY14 (USD18m) and an on-going USD50m cost efficiency programme. This is, however, slightly offset by a shortage of drivers and cost inflation running slightly above price indexation on most of the contracts that are yet to be rebid.

UK Bus Improving Steadily
FirstGroup's bus operations in the UK had a small drop in revenue over the year due to a disposal of operations in FYE14, but like-for-like revenue increased 2.3% as a result of like-for-like volumes improving 1.1% in FY15. The company rebased its bus fares in FYE14 and was therefore able to successfully implement price increases in line with market trends over FYE15. This, coupled with ongoing cost efficiency programmes, resulted in the operating margin improving by 1% from last year, slightly above Fitch's expectation.

The potentially negative impact of devolving transport powers to local authorities in the UK which may affect operating margins for bus operators, including FirstGroup, is not expected in the near term.

Greyhound Division under Pressure
Revenues in the Greyhound division fell 2.4% in FY15, which was below our expectation for the year (0.5% yoy on a constant currency basis). The main causes of the underperformance were low fuel prices, which encouraged customers to use alternative forms of transport, and the strengthening of the US dollar against the pound.

EBITA margins declined 0.6% due to demand shift, cost inflation and increased expenditure on product improvements and marketing. Fitch expects the demand impact of low fuel prices to annualise in 2H16 and margins to start benefiting from yield management.

Smaller Rail business
FirstGroup's UK rail division revenue declined 23% yoy in FYE15 due to the loss of the First Capital Connect franchise in September 2014, a reduction in the First ScotRail franchise subsidy and the end of revenue support arrangements for the First Great Western franchise. However, the low margin nature of the business (FYE15 operating margin of 3.4%) limited the impact of the revenue movement on the group's operating profit.

Uncertainty remains for FirstGroup's UK rail portfolio as the company has recently lost the First ScotRail and the First Capital Connect franchises and is bidding for two new franchises. Fitch forecasts assume no new franchise wins, and a small increase in current franchise profitability partially offset by the impact of recent strike action.

First Transit Division Stable
The bus and maintenance service division in North America improved revenue in FY15 by 4.1% from FY14, in line with Fitch's expectation. This was driven by organic growth on existing contracts and the timing of recent contract awards. The margin decreased to 7.1% in FY15 from 7.4% in FY14, as expected, on the back of lower revenue on renewed contracts although the margin remained above Fitch's expectation for the year. Fitch expects revenue in this division to see low single-digit growth and margins to slightly improve above 7% as lower margin contracts run out and further cost savings are made.

KEY RATING ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
-Resumption of dividend payments in FYE17
-Capex comparable to current levels
-No major acquisitions or disposals
-No new rail franchise wins

RATING SENSITIVITIES
Positive: Future developments that could lead to positive rating actions include:
-FFO adjusted net leverage sustainably below 3.0x (FYE15: 3.1x)
-FFO fixed charge cover at or approaching 4.0x (FYE15: 3.9x)
-Positive FCF (before disposals)

Negative: Future developments that could lead to negative rating action include:
-FFO adjusted net leverage consistently above 3.5x
-FFO fixed charge cover significantly below 3.5x for a sustained period
-Sustained negative FCF
-Weakening in the business profile, including unfavourable developments in the UK rail franchising process

LIQUIDITY AND DEBT STRUCTURE
At FYE15 FirstGroup had unrestricted cash of GBP224m (FYE14: GBP192m) in addition to GBP800m (FYE14: GBP796m) of undrawn committed facilities. This is more than sufficient to cover its short-term financial liabilities of GBP136m (FYE14: GBP127.8m). There are no material debt maturities falling due until 2018 when the GBP300m bond matures. Fitch expects FCF to be negative in FYE16 and neutral to negative thereafter as improved operational performance is offset by Fitch's assumption of dividend reinstatement in FYE17.