OREANDA-NEWS. Fitch Ratings has affirmed Stagecoach Group plc's (Stagecoach) Long-term Issuer Default Ratings (IDR) and senior unsecured rating at 'BBB'. The Outlook on the IDR is Stable. The Short-term IDR has been affirmed at 'F3'

The affirmation reflects the stable revenue and earnings visibility of Stagecoach's UK Bus (Regional), UK Bus (London) and UK Rail operations, and expected future growth in its North America and European bus businesses. Stagecoach has lower leverage than its peers, a comfortable level of fixed charge cover and is generally cash flow positive.

Stagecoach has periodically returned excess cash to shareholders. The most recent return in 2011 coincided with low leverage, which allowed the company to remain within the rating category. We expect Stagecoach to protect its ratings to support its bidding for rail franchises and other contracts and to maintain cost effective sources of funding.

KEY RATING DRIVERS
Stable Group Operating Performance
Stagecoach's overall performance was in line with Fitch's expectations for FY2015. Revenues were higher than Fitch's forecast mainly due to improved turnover at the UK Bus (Regional) and UK Bus (London) divisions. Margins for FY15 were slightly lower than Fitch's forecasts due to UK Rail paying higher premiums to the Department for Transport (DfT) at the end of rail franchises, and a difficult North American environment due to competition arising from lower fuel prices.

Stagecoach's operating profit, excluding joint ventures (JVs), was in line with Fitch's expectation for the year at around GBP200m. As expected, FY15 operating costs did not benefit from the full effect of lower fuel prices due to the company's conservative fuel hedging policy. The lagged benefit of lower fuel prices is expected to flow through in FY16 and FY17.

Regional Bus Driving Profits
UK Bus (Regional) is Stagecoach's largest division, contributing around 32% of revenue and 62% of operating profit in FY15. Revenue growth was stable, increasing 3.2% from FY14, due to improved commercial and concessionary revenue more than offsetting the decline in one-off revenue from the Glasgow Commonwealth games. However, operating profit in FY15 fell as a result of margins declining by 110bps to 13.5%. This was caused by the expansion of Megabus into Europe and staff costs from additional vehicle mileage increasing at rates above inflation.

Threat from UK Bus Devolution
The key operating risk for Stagecoach is the potential for the devolution of transport powers to local authorities in the UK (outside London) and the possible widening of the London bus franchising model to other metropolitan areas. This would likely result in lower profitability from bus operations, albeit offset by lower revenue risk. Stagecoach estimates that less than 25% of its revenue in its UK Bus (regional operations) would be affected by devolution of transport powers in areas where bus service franchising is being actively discussed.

Stronger London Bus Performance
Revenues from London Bus operations grew 6.4% to GBP261m in FY15, driven by higher contracted revenues despite lower incentive income. Operating margins improved by 0.3% to 10.1% as a result of a positive movement in insurance provisions, reduced fuel costs and the gain on sale of a bus depot, which offset increased staff and leasing costs. Transport for London plans to increase bus mileage by 5% by 2020, supporting revenue and margin stability.

Difficult North American Market
North American operations were adversely affected by the drop in fuel prices, which increased competition from car usage. A strengthening dollar against the euro also affected the sightseeing and tour operations. However, FY15 like-for-like revenue was stable at around GBP425m. The operating profit margin fell around 0.3% to 5.2% for the year as margins were further impacted by a one-off increase in the insurance provisions for the division. Continued low fuel prices and strong dollar exchange rate could stifle growth in North America in the near term.

UK Rail Steady Growth
UK rail revenue increased by 18% in FY15 driven by an increase in underlying volumes, start of the East Coast franchise and the recovery of lost revenue following engineering works on the East Midlands franchise. Margins fell by 90bps to 1.8% as two franchises paid higher premium amounts to the DfT. The West Coast joint venture with Virgin was revised to a new commercial franchise agreement from the previous management contract, leading to operating profit (recorded as JV income), jumping to GBP28.0m in FY15 from GBP2.6m in FY14.

UK Rail revenue and profit is likely to increase in FY16 as the new East Coast franchise is consolidated for the full year, although medium-term future organic growth may be impacted pending the potential introduction of Open-Access routes. South Western, West Coast and East Midlands franchises are due for expiry between 2017 and 2018 (pending East Midlands direct award). This may be offset by franchise renewals and new franchise wins; Stagecoach is shortlisted for the Transpennine Express and the East Anglia (in JV with Abellio) franchises.

Credit Metrics Adequate
FFO adjusted net leverage exceeded Fitch's negative rating sensitivity of 2.5x in FY2015 as a result of increased capex and dividends during the year. However, we expect Stagecoach to meet leverage guidelines and that capex and dividend flexibility will moderate cash outflows in the event of a lower than forecast operating performance. FFO fixed charge cover at around 5.0x and positive free cash flow generation were in line with Fitch's guidelines for a 'BBB' rating.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Stagecoach include:
- Conversion of some of the UK Bus (Regional) operations into a franchise model from FY18 post devolution of transport powers to local authorities
- No new UK Rail franchise wins
- Capex at elevated levels for two years until FY18
- High single digit growth in dividends pa over the next four years

RATING SENSITIVITIES
Negative: Future developments that could lead to negative rating action include:
- FFO net adjusted leverage to above 2.5x.
- FFO fixed charge cover consistently below 5.0x.
- Negative FCF due to a significant deterioration in operational performance or franchise losses, higher dividends or shareholder returns.

Positive: Future developments that could lead to positive rating action include:
- FFO net adjusted leverage below 2.0x.
- FFO fixed charge cover trending towards 7.0x.
- Positive FCF, although Stagecoach has historically returned excess cash to shareholders, limiting the scope for rating upside.

LIQUIDITY
Sufficient Liquidity
Fitch considers Stagecoach's liquidity adequate. Stagecoach had GBP114m of unrestricted cash at 30 April 2015 and GBP299m of undrawn committed bank facilities, which comfortably covers short-term debt of only GBP51.6m. We expect Stagecoach to refinance its GBP400m 5.75% notes due in December 2016 before their maturity and broadly maintain the current capital structure.