UK Bus (regional operations)

 

 

Summary

·  Revenue per vehicle mile up 2.7% ·  Investment in fleet, technology and enhancing customer experience ·  Strong customer satisfaction

 

Financial performance

 

The financial performance of the UK Bus (regional operations) Division for the year ended 28 April 2018 is summarised below:

 

	2018 £m	2017 (restated) £m	Change
Revenue	1,012.5	1,015.7	(0.3)%
Like-for-like revenue *	1,012.3	1,013.8	(0.1)%
Operating profit*	112.9	117.0	(3.5)%
Operating margin	11.2%	11.5%	(30)bp

 

^* see definitions in note 22 to the condensed financial statements

 

Actions we took in early 2017 to adjust our pricing and network of services to respond to changes in customer demand have helped reduce pressure on the profitability of the business and ensure we can continue to invest in customer improvements. We have worked closely with our local authority partners as part of our focus on operating sustainable networks and maximising the value of our combined resources.  Like-for-like vehicle miles operated were 2.7% lower than in the previous year.  The vehicle miles we operate on a commercial basis were reduced by 1.7% with greater reductions in the mileage tendered by local authorities and operated under contract.  Reflecting the management actions taken, like-for-like revenue per vehicle mile grew 2.7% and like-for-like revenue per journey also increased 2.7%.

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Like-for-like revenue was built up as follows:

 

	2018 £m	2017 £m	Change
Commercial on and off bus revenue
- megabus.com	24.1	22.0	9.5%
- other	612.0	602.1	1.6%
Concessionary revenue	242.5	247.9	(2.2)%
Commercial & concessionary revenue	878.6	872.0	0.8%
Tendered and school revenue	97.9	100.4	(2.5)%
Contract and other revenue	35.8	41.4	(13.5)%
Like-for-like revenue	1,012.3	1,013.8	(0.1)%

 

The growth in commercial revenue reflects the actions we have taken to improve yield per journey, partly offset by the impact of more severe weather in the second half of the year which restricted our ability to run some services and suppressed demand. In particular, the reported like-for-like revenue growth for our four-week reporting period ended 3 March 2018 was suppressed by the widespread snowstorms throughout the UK.  During that period, the Division's like-for-like revenue declined by 2.5% from the equivalent prior year period, illustrating the scale of the impact of these extreme weather conditions.  We estimate the operating profit would have been c.£2m higher but for the adverse weather conditions relative to last year. Our strategy for growth and customer satisfaction is centred on low-fares, operational excellence and continued investment.

 

Our megabus.com business in the UK performed well in the second half of the year, following weakness in the inter-city coach market in the first half of the year. We are encouraged by the impact of the measures we have taken to improve yield management and modify the network. In addition, we have refreshed our marketing to maximise the value of the brand.

 

The decline in concessionary revenue includes the effects of the adverse weather and the continuing effects of government changes in the age of eligibility for free bus travel by older people, as we have previously reported.  We have also seen a reduction in the concessionary reimbursement rate paid to bus operators in several regions, including Manchester, and lower financial support in Wales for bus travel by young people.

 

We continue to work with local authorities to maximise the value for local communities from the financial support councils can provide for socially desirable transport services.  The decline in tender revenue mainly reflects further reductions by local authorities for tendered bus services and we anticipate some further cuts over the next year.

 

The reduction in contract and other revenue include the effects of lower rail replacement contract revenues, in addition to year-on-year changes in the amount and timing of one-off contract and events work.

 

The movement in operating margin was built up as follows:

 

Operating margin - 2016/17 (restated)	11.5%
Change in:
Insurance and claims costs	0.8%
Staff costs	(0.8)%
Fuel costs	0.7%
Depreciation and amortisation	(0.4)%
Gain on disposal of land and buildings	(0.3)%
Other	(0.3)%
Operating margin - 2017/18	11.2%

 

 

The main changes in the operating margin shown above are:

 

·      We have seen positive progress on claims costs with the costs for the year being below last year and less than we expected.

·      Staff costs, as expected, have continued to rise, and not all headcount varies with vehicle miles.  Staff costs include provisions for additional holiday pay costs and the full year impact of the new Apprenticeship Levy applied by the UK Government from April 2017 to fund new apprenticeships. However, wage awards in the year are in line with our forecast assumptions, staff retention rates remain stable and staff costs remain under control.

·      Fuel costs have reduced, reflecting market fuel prices and our fuel hedging programme.

·      Gains on the disposal of land and buildings reduced year-on-year.

·      Other costs have increased, including higher depreciation and amortisation as a result of our continued investment.

Enhanced products and customer experience

 

We are continuing to invest in our fleet, technology and customer service to attract people to the benefits of bus travel. Following several years of substantial capital investment in our regional bus operations, our expenditure on new vehicles has moderated to reflect the changes we have made in a number of our local bus networks. We have placed orders for around 170 new buses for 2018/19, representing an investment of around £40m.

 

We are now well advanced with our roll-out of contactless ticketing across our bus and coach operations in the UK as part of our multi-million pound digital strategy. The technology is now available at many of our regional bus operations in Scotland and England, as well as at our Scottish Citylink inter-city coach joint venture, with contactless payments expected to be in place on all vehicles by the end of 2018. Stagecoach Group won the award for Best Smart Ticketing Project at the 2018 Transport Ticketing Global Awards for the contactless project, which is one of Visa's fastest growing transit schemes in Europe and is also compatible with Apple Pay and Android Pay.

 

In July 2017, we launched a blueprint to help ensure bus services can effectively serve new housing developments being planned across the country. Failure to integrate public transport to new developments results in a greater cost to the economy in lost productivity, poorer air quality, longer working days because of extra commuting time and a less safe living environment with more cars on the road.

 

Providing value travel is a central element of our growth strategy. In our annual national travel mode comparison, our research found that people who use the bus to commute are on average £1,200 per year better off than those travelling to work by car who pay for fuel and parking.

 

Satisfaction with Stagecoach bus services has risen to 90%, according to independent research published by consumer watchdog, Transport Focus, in March 2018. Stagecoach achieved the biggest improvement in overall passenger satisfaction of any major UK operator. Customers once again rated Stagecoach as the best value of the major UK bus operators, for the fifth year in a row.

 

Commercial growth initiatives

 

With declining propensity to travel in the UK presenting challenges, our UK Bus commercial team is progressing a package of initiatives to respond to changing demand for travel driven by evolving work and social patterns, as well as capitalising on opportunities for growth through technology, more effective marketing and product development. Specific actions underway, to support this and our continued focus on safety, punctuality and reliability include:

 

·      Revised Stagecoach brand strategy to leverage its strength as a trusted travel provider.

·      Improved online presence for our main megabus.com and Oxford Tube inter-city travel products and further development of inter-urban/express coach services.

·      Simpler pricing and ticketing.

·      Enhanced functionality of the Stagecoach bus app and better delivery of real time journey information.

·      Evaluation of opportunities for more demand responsive services in a number of locations, as well as the UK's first pilot of autonomous vehicle technology on a standard bus.

·      Driving a more agile and entrepreneurial culture at local operating companies, supported by a complementary recruitment strategy.

·      Fostering joint working to maximise the opportunities from closer integration of bus and rail.

·      Using improved understanding of the segmentation of our existing and potential customer base to identify the profile and triggers to travel for non-users.

·      Implementing a new customer relationship management ("CRM") system to engage and improve customer loyalty and yield.

·      Increasing the volume of work we undertake to support events, festivals and other businesses, where new technology can support an increased capability to grow revenue in these areas.

Stakeholder engagement

 

Along with other bus industry groups and other industry stakeholders, we are continuing to make the case for the role of the bus in tackling congestion and air quality. We are pleased that a number of local authorities have started to recognise the important role of Euro VI buses in their draft plans to tackle pollution in their areas, with many exempting retrofit buses from charging Clean Air Zones ("CAZs"). The UK Government's new £48m Ultra-Low Emission Bus Scheme, available for local authorities and operators in England and Wales to support the next generation ultra-low emission bus technologies, is also welcome. However, we believe further action is needed by local authorities to prioritise meaningful action to tackle the biggest polluter, the diesel car, which a 2017 Greener Journeys report notes is currently responsible for 41% of all nitrogen oxides emissions compared to just 6% for buses. In addition, we have called for clearer Government guidance for councils on CAZs to encourage a shift towards buses and other cleaner modes of transport with 38 of England's 43 air quality zones currently breaching EU legal limits for nitrogen oxides emissions. We are also engaging with the Scottish Government and authorities in Glasgow, Edinburgh, Aberdeen and Dundee over planned low emission zones in those cities.

 

Outlook

 

Consistent with 2017/18, we have implemented further vehicle mileage reductions for 2018/19 and applied some price increases where appropriate. We continue to expect modest revenue growth from our local bus services in the short-term. Our costs remain well controlled, with higher pay and pension costs for staff being partially mitigated by expected lower fuel costs.

 

We have not significantly changed our expectation of the Division's operating profit for the year ending 27 April 2019 since our last update on trading.

 

Recent years have seen a reduction in people's propensity to travel in the UK.  There are factors outside of the control of bus operators that are influencing travel choices including the growth in online services and home delivery, changes in working patterns, road congestion and changes in car costs from improved vehicle efficiency and changes in fuel prices.  While there are undoubtedly challenges to growing bus patronage in the longer term, we still see cause for optimism.  Forecast further population growth, particularly in urban areas presents opportunities for growing bus patronage.  Mass transit, including buses, can help mitigate the risk of population growth in urban areas contributing to worsening road congestion and air quality challenges.  Indeed, we would welcome more proactive policy interventions to encourage mass transit use and reduce car use to address these increasing problems.  Technological advances may support new entrants to the transport space but they also allow greater personalisation of bus travel, improved customer relationship management and further operating cost efficiencies, thus making services more attractive to customers.  Younger people are learning to drive later, are buying cars later and are more comfortable in the "sharing economy", in which buses have a role.  In some areas, younger people are also benefiting from policy initiatives that make bus travel more attractive.  Against that background, we continue to adjust our regional UK Bus networks to provide additional capacity where demand is growing and reduce capacity to remain cost competitive in areas of reducing demand.  We continue to invest in technology and to pilot new ways of working.  We see an exciting future for our regional UK Bus operations as we navigate the challenges and build on the opportunities we already see.

 

UK Bus (London)

 

Summary

·  Positive tender results ·  Maintaining sustainable contract pricing ·  New depot facility added in South East London

 

 

Financial performance

 

The financial performance of the UK Bus (London) Division for the year ended 28 April 2018 is summarised below:

 

	2018 £m	2017 £m	Change
Revenue and like-for-like revenue	251.8	263.4	(4.4)%
Operating profit	13.3	18.4	(27.7)%
Operating margin	5.3%	7.0%	(170)bp

 

During the year, we have won several new contracts from other operators which we will run on behalf of Transport for London. We have made a net gain of four routes with a peak vehicle requirement of 50 buses and a total contract value of close to £13m. That should benefit our revenue in the next financial year, 2018/19.  The revenue impact of contracts lost in the prior year is reflected in this year's financial performance and related revenue decline of 4.4%.

 

The movement in operating margin was built up as follows:

 

Operating margin - 2016/17	7.0%
Change in:
Staff costs	(0.6)%
Operating lease costs	(0.6)%
Impairment of vehicles	(0.6)%
Fuel costs	0.5%
Other	(0.4)%
Operating margin - 2017/18	5.3%

 

Consistent with the UK Bus (regional operations), the new Apprenticeship Levy has added to the UK Bus (London) Division's staff costs in the year.  The current year staff costs also reflect pay awards and the implementation of previously disclosed plans to increase starting rates of pay for bus drivers.

 

Operating lease costs have moved as a percentage of revenue, principally due to year-on-year changes in end of lease vehicle return costs.

 

The increased impairment expense arises from the impairment of the carrying value of older, owned vehicles that became surplus to requirements during the year.

 

Fuel costs have reduced, reflecting market fuel prices and our fuel hedging programme.

 

We see significant differences in the level of bus depot capacity versus the demand from Transport for London for bus services across the different areas of London.  We are exploring the extent to which that presents us with opportunities for growth and/or possible re-deployment of capital. In March 2018, we opened a new depot at Lower Sydenham in South East London. This additional facility will increase our bid capability by providing extra capacity and a modest geographical extension.

 

We are continuing to innovate and recently launched a new low-cost sightseeing product in London, megasightseeing.com. Leveraging the profile of our megabus.com brand, the service offers a pre-booked two-hour non-stop double-decker bus tour of 50 famous tourist sights with GPS commentary. Around 19 million tourists visit London every year and we believe our significantly lower fares will provide an opportunity to gain a profitable share of the current market as well as to expand it.

 

Outlook

 

We currently expect our UK Bus (London) operating margin to remain below our long-term aspiration of 7% in the year ending 27 April 2019. Staff cost inflation in excess of what was assumed in previous successful bids for contracts is affecting profit but our revised expectation of staff and other costs is reflected in our bids for new contracts.  We continue to monitor Transport for London's plans to reduce contracted bus mileage in London, and will seek to maintain our contract pricing at a sustainable level where service quality can be maintained and the financial returns reflect the capital invested.

 

North America

 

Summary

·  Profit and revenue in line with our expectations ·  Continued focus on new contract wins ·  New megabus.com website performing well

 

Financial performance

 

The financial performance of the North America Division for the year ended 28 April 2018 is summarised below:

 

	2018 US$m	2017 (restated) US$m	Change
Revenue	630.0	632.3	(0.4)%
Like-for-like revenue	628.7	630.6	(0.3)%
Operating profit	28.1	23.5	19.6%
Operating margin	4.5%	3.7%	80bp

 

Like-for like revenue for the year is broadly in line with our expectations. Revenue trends in the second half of the year were lower than growth seen in the first half, reflecting the timing of contract work during the year and more severe weather than our forecasts anticipated over the winter months. 

 

Like-for-like revenue was built up as follows:

 

	2018 US$m	2017 US$m	Change
megabus.com	185.8	192.4	(3.4)%
Scheduled service
-    Commercial revenue	156.2	157.7	(1.0)%
-    Support from local authorities	20.2	20.5	(1.5)%
Charter	111.2	118.5	(6.2)%
Contract services	134.7	117.8	14.3%
Sightseeing and tour	20.6	23.7	(13.1)%
Like-for-like revenue	628.7	630.6	(0.3)%

 

The like-for-like revenue decline of 0.3% for the Division includes a 3.4% decline for megabus.com North America, reflecting previously implemented mileage changes in the network to better match our services to customer demand.  megabus.com revenue per mile for the year was up 1.0%.  The other businesses in North America reported like-for-like revenue growth of 1.1% for the year.

 

The movement in the operating margin was built up as follows:

 

Operating margin - 2016/17 (restated)	3.7%
Change in:
Fuel costs	1.2%
Staff costs	(0.5)%
Other	0.1%
Operating margin - 2017/18	4.5%

 

The main changes in the operating margin shown above are:

 

·      Fuel costs have reduced reflecting market fuel prices and our fuel hedging programme.

·      Staff costs have continued to rise as a proportion of our revenue base.  That includes increased overtime levels at some locations, where we are working to recruit new drivers to reduce the need for overtime working.  In addition, the improved financial performance of the Division is reflected in higher staff incentive costs.

Business development

 

We continue to be encouraged by further additional revenue generated from our focus on contract opportunities. In the first half of the year, we benefitted from rail replacement contracts linked to train disruptions on New Jersey Transit and Long Island Rail Road as a result of track repair work at Pennsylvania Station in New York.  This contributed to a reduction in charter revenue as we deployed some vehicles on the rail contract work that would otherwise have been available for charter. We have since benefitted from further smaller rail replacement projects in New York and Maryland. Given the pressure on rail infrastructure, we are hopeful of more opportunities in the short-term. A contract with Bechtel secured in early 2017, moved from start up to full operation in the 2017/18 financial year.

 

We have launched Virginia Breeze, created with part financial support from the state's transportation department, with tickets sold on megabus.com and linking into its wider network. It connects Virginia with Washington DC and has several stops including Dulles International Airport.

 

We are delighted with the successful start of our Airport Express service offering fast, convenient transfers between Stewart International Airport and New York City. 40% of all of the Norwegian airline's passengers flying into the airport are taking our bus service.

 

As previously reported, we took steps last year to consolidate the megabus.com network to reflect demand in an environment of low fuel prices. We are encouraged by the impact of these management actions and also our ability to retain market share in the highly competitive Northeast corridor. However, we are continuing to develop our product offer and marketing to promote the benefits of low-cost inter-city coach travel.

 

The investment we have made in our new megabus.com website has improved our customers' experience and is supporting our growth.  The new website provides a much improved mobile experience and we have seen clear evidence of this translating through into seat sales. The website's new functionality has allowed us to improve our search engine rankings and we have developed online route and destination content to drive traffic to the website. During the year, we launched Megabus RIDE, our new smartphone and tablet app which allows customers to choose from dozens of movies and TV shows on their journey via our free on board Wi-Fi. We are also continuing to refine our yield management approach at megabus.com to maintain our reputation for good value for money while improving yield based on patterns of demand.

 

Elsewhere in our portfolio, weak sightseeing markets have impacted some of our services, and we have restructured our sightseeing operations as we seek to improve profitability.

 

Outlook

 

During 2018/19, we are looking to build on the benefits of the management actions taken during 2017/18 to match services with customer demand at our megabus.com inter-city coach business. Rising fuel prices should help support demand for our services.

 

We also continue to see growth opportunities from the Division in new contract wins but will remain disciplined in ensuring that we bid for contract opportunities at prices consistent with delivering appropriate rates of return.

 

UK Rail

 

Summary

·  Good profits from East Midlands Trains and South West Trains ·  Greater clarity on Virgin Trains East Coast - franchise terminated in June 2018 ·  East Midlands Trains franchise extended to March 2019, with plan for further Direct Award ·  Bids for new franchises ·  UK rail franchises moving to a more balanced risk profile

 

Financial performance

 

The financial performance of the UK Rail Division for the year ended 28 April 2018 is summarised below:

 

	2018 £m	2017 (restated) £m	Change
Revenue	1,495.2	2,160.7	(30.8)%
Like-for-like revenue	1,183.7	1,142.6	3.6%
Operating profit	24.9	28.5	(12.6)%
Operating margin	1.7%	1.3%	40bp

 

Our UK Rail business continues to see growth in revenue, with like-for-like revenue up 3.6% year-on-year.

 

The South West Trains franchise expired in August 2017. Profitability during the year was strong and included the resolution of a number of contractual matters as part of the transition of the train operations to a new operator.

 

The UK Rail Division's reported profit reflects the utilisation of the onerous contract provision recorded at April 2017 in respect of the original contractual arrangements at Virgin Trains East Coast. As forecasted, Virgin Trains East Coast continued to incur trading losses under that contract, which have been applied against the onerous contract provision.

 

Virgin Trains East Coast

 

While we were surprised and disappointed by the decision announced by the Secretary of State for Transport on 16 May 2018 to transfer responsibility for operating the East Coast train services from Virgin Trains East Coast to a publically owned company, we welcome the clarity that decision brings.  The transfer occurred on 24 June 2018.  The subsidiary company, East Coast Main Line Company Limited, which traded as Virgin Trains East Coast, remains part of the Group and there are a number of matters to unwind over the coming months.

 

The decision is consistent with the Secretary of State for Transport's statement in the House of Commons on 5 February 2018, where he intimated that he was considering two options for the continued operation of the InterCity East Coast services.  The financial consequences of that for Virgin Trains East Coast are 90% attributable to the equity holders of the Company and 10% attributable to Virgin's non-controlling interest in Virgin Trains East Coast.  In our announcement that day, we indicated that the Secretary of State's position on Virgin Trains East Coast could result in Stagecoach Group plc funding up to a further £19m in cash (£21.0m being payable by the Company to the Department for Transport, with £2.1m of that being attributable to the non-controlling interest) and incurring a further consolidated expense of up to £94m, after taking account of tax and deducting the 10% Virgin non-controlling interest.  We noted that could result in the Group's consolidated non-rail net debt being up to around £19m higher than previously forecast but that the other elements of any expense should not affect non-rail net debt.  The net cash outflow of £19m is expected to occur in June 2018. The net exceptional expense after tax for the year ended 28 April 2018 was £93.9m, of which £85.6m was attributable to the equity holders of Company and is within the previously reported range of up to £94m. The net expense is analysed below, with the effects of tax and the amounts attributable to the non-controlling interest separately shown:

 

	Exceptional income statement expense £m	Exceptional other recognised expense £m	Total recognised exceptional expenses £m
Liability re performance bond	(21.0)	-	(21.0)
Increase in onerous contract provision and adjustments to carrying value of assets and liabilities	(28.0)	-	(28.0)
Pensions actuarial loss	-	(32.9)	(32.9)
Loss before tax	(49.0)	(32.9)	(81.9)
Tax	(14.5)	2.5	(12.0)
Loss after tax	(63.5)	(30.4)	(93.9)
Non-controlling interest	5.6	2.7	8.3
Loss attributable to equity holders of the parent	(57.9)	(27.7)	(85.6)

 

We regret the losses the Group has experienced on the East Coast franchise, notwithstanding that these were significantly influenced by factors outside of our control.  We have examined our bid for and operation of the franchise closely and have also looked more broadly at our rail bid governance.  We involved external advisors in that and we have made changes to our processes to strengthen our approach to bidding and contract management in UK rail.  The lessons learnt have been reflected in our subsequent bids.

 

East Midlands Trains

 

Like-for-like revenue at East Midlands Trains grew by 3.5% for the year. While growth in the first half of the year was adversely affected by the terrible terrorist events in London and Manchester, performance in the second half of the year has been stronger.  The business continues to deliver good levels of profitability.

 

During the year, the Department for Transport exercised its pre-contracted option to extend the East Midlands Trains franchise to March 2019, with plans for a further Direct Award franchise beyond that time.  The Department for Transport currently expects the Direct Award franchise to run from March 2019 to the anticipated start of the next competitively tendered franchise in August 2019.  The current franchise is subject to a GDP risk sharing arrangement with the Department for Transport that reduces the train operator's exposure to significant changes in GDP. We are progressing work on our bid for the next competitively tendered East Midlands franchise.

 

East Midlands Trains has had the highest punctuality of any of the UK franchised long distance train operators for the last eight years.

 

We have worked in partnership with Network Rail to support work on the biggest upgrade of the Midland Main Line since it was completed in 1870, alongside the Government-sponsored £7bn Thameslink programme. A new timetable was introduced in May 2018, one of the biggest changes in recent railway history. It includes some changes to East Midlands Trains services to accommodate extra peak-time seats, improved journey times and better connections on the Thameslink network. The Midland Main Line upgrade programme is due for completion in 2020. We have also been working in close partnership with Network Rail, CrossCountry and Transport Focus on operational planning and customer communications around the major Derby resignalling programme taking place from this summer. The £200m project will improve journeys to and through Derby railway station, and will also provide a new platform and new track. Most recent independent research shows that 87% of East Midlands Trains customers are satisfied with its services.

 

South West Trains

 

In August, we completed the operational delivery of our South Western rail franchise, working collaboratively with the new operator and industry partners to ensure a smooth transition.  There remain a number of assets and liabilities of South West Trains as at 28 April 2018, where the amounts due will be confirmed and settled with the counterparties in the months ahead.

 

Sheffield Supertram

 

Passenger satisfaction with Sheffield Supertram has risen to the second highest level on record at 95%.

 

The first passenger service of the new vehicles to be used for the innovative Tram Train project took place at Sheffield Supertram in September.  The project, which will improve journeys between Sheffield and Rotherham, is the first of its kind in the country. Testing of the trams with new infrastructure is being undertaken to allow driver training to begin this summer, with full services due to start towards the end of 2018. We have also made the first changes to the Supertram timetable in 15 years to improve reliability and peak capacity following a significant increase in road traffic.

 

Franchising update

 

We are working on new opportunities in the UK franchised rail market and are pleased at the steps taken by the Department for Transport to deliver an improved risk-reward balance in new franchise competitions. We are also encouraged to see signs of moderation in the level of capital put at risk on individual franchises, which we believe should be commensurate with the potential financial returns.

 

Earlier this year, we submitted our bid for the South Eastern franchise, which serves passengers in south-east London and parts of Kent and East Sussex. Stagecoach is one of three bidders shortlisted for the new South Eastern franchise. We were pleased to confirm in February our intention to form a relationship with Alstom Transport UK Limited (part of the Alstom SA Group) for that rail franchise, subject to Department for Transport consent.  It is intended that Alstom will hold 20% of the share capital of the train operating company if our bid for the franchise is successful.  Around a third of all rail journeys in the UK are made on Alstom trains, including the flagship Pendolinos that run on the West Coast route.

 

We are also bidding for the West Coast Partnership franchise jointly with SNCF and Virgin Group. The invitation to tender for the new West Coast Partnership was issued in March. Stagecoach has a 50% share in the bid vehicle, with SNCF holding 30% and Virgin 20%. Our objective is to work with stakeholders to create a new service that offers a world class customer experience whilst delivering value for local communities and supporting economic growth.

 

Stagecoach has also started work on its bid for the next competitively tendered East Midlands franchise, where it is one of three shortlisted bidders. The Department for Transport issued the invitation to tender in June and the new franchise is expected to begin in August 2019.

 

We have delivered good investor returns from UK rail over more than 20 years and some of the biggest returns for taxpayers. We are focused on ensuring that any bid for a new franchise is designed to achieve an acceptable balance of risk and expected reward and based on the emerging re-balancing of risk in UK rail franchises, we are optimistic that we can deliver satisfactory financial returns from UK rail.

 

Outlook

 

Our UK Rail operating profit for 2018/19 is expected to decline, with anticipated profit from the East Midlands Trains franchise being partly offset by the costs of bidding for new opportunities.

 

Revenue growth across the UK rail sector has strengthened in recent months, albeit remaining below levels typically seen since privatisation in the 1990s. In any event, our current major franchise at East Midlands Trains, has limited exposure to revenue risk because it has only around nine months to run and benefits from a GDP sharing arrangement with the Department for Transport. In our proposals for new franchises, we will assess revenue trends, revenue risk sharing arrangements and longer term revenue expectations to ensure we do not take unacceptable rail revenue risk.

 

We are positive on new franchise opportunities.  We welcome the introduction of the "Forecast Revenue Mechanism" by the Department for Transport, where the Department for Transport shares in variances in revenue versus forecast, which should significantly reduce the likelihood of a future rail franchise experiencing the extent of the financial challenges that we encountered at Virgin Trains East Coast. The new FRM mechanism is an important factor in our decision to continue bidding for UK rail franchises. Taking account of that, the moderation of the levels of risk capital required for a franchise, the work we have undertaken to learn lessons from our experience at Virgin Trains East Coast, our expertise in rail bidding and operations, and the relatively few bidders in each recent franchise competition means we believe we can earn good financial returns from UK rail in the coming years as well as continue to deliver improvements for customers and value for taxpayers.

 

Joint Ventures

Virgin Rail Group

 

Summary

·  Continuing good financial performance ·  High customer satisfaction ·  New Direct Award franchise

 

Financial performance

 

The financial performance of the Group's Virgin Rail Group joint venture for the year ended 28 April 2018 is summarised below:

 

49% share	2018 £m	2017 £m
Revenue	574.0	556.8
Operating profit	30.0	31.5
Net finance income	0.4	0.5
Taxation	(4.5)	(7.2)
Profit after tax	25.9	24.8
Operating margin	5.2%	5.7%

 

Virgin Rail Group's West Coast rail franchise delivered like-for-like revenue growth of 3.1% for the year ended 28 April 2018 and a good profit margin.  The lower effective tax rate in the year reflects an adjustment to prior years' tax following the tax authority closing its enquiry into a previous tax return.

 

In February 2018, Virgin Rail Group agreed a new Direct Award franchise on West Coast which runs through to at least 31 March 2019, with the option for up to a further one-year extension at the Department for Transport's discretion.  The contract bridges the gap between the existing franchise, which ended in March 2018, and the new West Coast Partnership, due to start in September 2019. Under the new franchise, a revenue share arrangement with the Department for Transport applies whereby the Department for Transport bears 90% of the risk of any difference in excess of 1% between the forecast revenue reflected in the contract and actual revenue. This provides Virgin Rail Group with significant protection against movements in forecast rail revenue and enables the Department to share in revenue out-performance.

 

Under the Direct Award contract, Virgin Trains customers will see a significant improvement in on-board Wi-Fi on all 56 Pendolino trains and free Wi-Fi will be extended to all customers on these trains as part of a £7.5m investment. All station ticket machines are being upgraded to accept contactless payment as part of the new contract. More than £3m is being invested to improve station and on-train environments, including additional seating at stations and improved toilets, lighting and carpets on trains. Additional staff will be based at stations during busy times to improve accessibility, and better customer information will be available during disruption through an improved customer contact system. Virgin Trains is also creating new apprenticeship opportunities, including for train driver roles.

 

The new contract will allow Virgin Trains to build on 20 years of success on the West Coast route where it has almost tripled journey numbers from 14m a year to more than 38m and has consistently topped the long distance franchised sector for passenger satisfaction.

 

Outlook

 

Virgin Rail Group's operating profit in 2018/19 is anticipated to reduce, reflecting the full year effect of the contractual terms on the new Direct Award West Coast franchise.

 

Pre-exceptional EBITDA, depreciation and intangible asset amortisation

 

Earnings before interest, taxation, depreciation, intangible asset amortisation and exceptional items (pre-exceptional EBITDA) amounted to £334.4m (2017: £345.4m). Pre-exceptional EBITDA can be reconciled to the condensed financial statements as follows:

 

	2018 £m	2017 £m
Total operating profit	132.1	47.3
Exceptional items	47.8	128.7
Intangible asset amortisation	12.7	16.8
Depreciation	132.9	145.5
Impairment	4.5	-
Add back joint venture finance income & tax	4.4	7.1
Pre-exceptional EBITDA	334.4	345.4

 

Intangible asset amortisation reduced from £16.8m to £12.7m, reflecting the write-down in intangible assets at Virgin Trains East Coast in the previous year.

 

Depreciation reduced from the previous year reflecting the cessation of our South Western rail franchise.

 

Exceptional items

 

The following exceptional items were recognised in the year ended 28 April 2018:

·      As explained in the UK Rail section, an exceptional pre-tax expense of £81.9m has been recorded in respect of the Virgin Trains East Coast franchise. Of the total expense, £49.0m has been recognised in the consolidated income statement, with the remaining £32.9m recognised in the consolidated statement of comprehensive income, as it represents the actuarial loss in relation to the remeasurement of the pension asset arising from the termination of the franchise.

·      A pre-tax exceptional loss of £1.7m was recognised in respect of the closure of our Norfolk Green business within the UK Bus (regional operations) Division. Due to the non-recurring nature of business disposals, we present any such gains or losses as exceptional items to allow a proper understanding of the Group's financial performance.

·      A pre-tax exceptional gain of £1.2m was recognised in respect of a reassessment of liabilities for North America legal claims.

The net effect of exceptional items was a pre-tax loss of £49.5m (2017: £124.0m).

 

Net finance costs

 

Net finance costs for the year ended 28 April 2018 were £35.1m (2017: £34.1m) and can be further analysed as follows:

 

	2018 £m	2017 £m
Finance costs
Interest payable and other facility costs on bank loans, loan notes, overdrafts and trade finance	3.8	4.7
Hire purchase and finance lease interest payable	1.5	1.7
Interest payable and other finance charges on bonds	21.8	22.0
Unwinding of discount on provisions	3.5	3.5
Interest charge on defined benefit pension schemes	6.0	3.7
	36.6	35.6
Finance income
Interest receivable on cash	(0.7)	(1.2)
Effect of interest rate swaps	(0.8)	(0.3)
	(1.5)	(1.5)
Net finance costs	35.1	34.1

 

The modest increase in net finance costs is principally due to higher interest expense on defined benefit pension schemes arising from changes in market-driven assumptions used to determine pension amounts.

 

Taxation

 

Our share of profit from joint ventures is reported after tax in arriving at the profit before tax in the consolidated income statement.  To better understand the Group's effective tax rate, we show below the Group's tax charge including our share of joint ventures' tax relative to the Group's profit before tax excluding joint ventures' tax.  On that basis, the effective tax rate for the year ended 28 April 2018, excluding exceptional items, was 15.2% (2017: 17.5%).

 

The tax charge can be analysed as follows:

 

	Pre-tax profit £m	Tax £m	Rate %
Excluding exceptional items	149.6	(22.7)	15.2%
Exceptional items	(49.5)	(13.6)	(27.5)%
With joint venture taxation gross	100.1	(36.3)	36.3%
Reclassify joint venture taxation for reporting purposes	(4.8)	4.8
Reported in income statement	95.3	(31.5)	33.1%

 

 

The effective tax rate, excluding exceptional items, of 15.2% is lower than the 19.0% rate of UK corporation tax for the year. The difference is principally due to the utilisation of previously unrecognised tax losses and the release of liabilities for uncertain tax positions following the conclusion of a state tax audit in the US, the reclassification of the Group by Her Majesty's Revenue and Customs ("HMRC") to "low risk" and HMRC closing its enquiries into tax returns in respect of previous years.  Assuming the composition of the Group remains broadly unchanged and that there are no significant changes to expected corporate tax rates or laws in the UK, the US and Canada, we expect the Group's future effective tax rate (excluding exceptional items) to be between 17% and 20%.

 

The cash tax paid in the year of £16.3m (2017: £21.6m) compares to the tax charge for Group companies of £31.5m (2017: credit of £0.2m) shown above. The largest difference relates to the £13.6m tax charge recognised on exceptional items that has yet to affect cash tax.

 

The areas where the Group sees uncertainty around the amount of tax that is payable relate to losses incurred by Virgin Trains East Coast, the financing of and transactions with overseas operations and losses incurred by overseas operations in the ordinary course of business.

 

Fuel costs

 

The Group's operations as at 28 April 2018 consume approximately 385m litres of diesel fuel per annum. As a result, the Group's profit is exposed to movements in the underlying price of fuel. The Group's fuel costs include the costs of delivery and duty as well as the costs of the underlying product. Accordingly, not all of the cost varies with movements in oil prices.

 

The proportion of the Group's projected fuel usage that is now hedged using fuel swaps is as follows:

 

Year ending April:	2019	2020	2021
Total Group	79%	69%	43%

 

The Group has no fuel hedges in place for periods beyond April 2021.

 

Cash flows and net debt

 

Consolidated net debt (as analysed in note 17 to the condensed financial statements) has reduced in the year, notwithstanding operating cash outflows at Virgin Trains East Coast and the transfer of cash following the August 2017 expiry of the South West Trains franchise.  Consolidated net debt at 28 April 2018 was £395.8m (2017: £409.4m) and non-rail net debt was £567.0m (2017: £628.8m).  Although the consolidated net debt at 28 April 2018 is less than we expected, that largely reflects variations in the timing of UK rail cash flows.  The balance at 28 April 2018 includes £84.5m of Virgin Trains East Coast cash, which we expect will reduce to nil in the year to 27 April 2019 and we also expect further net cash outflows in respect of South West Trains as we conclude open matters relating to the expired franchise.  However, we do expect non-rail net debt to reduce in the year to 27 April 2019.
Net cash from operating activities before tax for the year ended 28 April 2018 was £208.8m (2017: £253.7m) and can be further analysed as follows:

 

	2018 £m	2017 £m
EBITDA of Group companies before exceptional items	302.9	312.1
Cash effect of exceptional items	-	(3.7)
Gain on disposal of property, plant and equipment	(3.2)	(4.3)
Equity-settled share based payment expense	1.2	1.9
Working capital movements	(93.0)	(53.7)
Net interest paid	(26.3)	(26.7)
Dividends from joint ventures	27.2	28.1
Net cash flows from operating activities before taxation	208.8	253.7

 

The movement in net debt, showing train operating companies separately, was:

 

Year to 28 April 2018	Train operating companies £m	Other £m	Total £m
EBITDA of Group companies before exceptional items	41.0	261.9	302.9
Gain on disposal of property, plant and equipment	(1.0)	(2.2)	(3.2)
Equity-settled share based payment expense	0.5	0.7	1.2
Working capital movements	(129.2)	36.2	(93.0)
Net interest paid	(2.8)	(23.5)	(26.3)
Dividends from joint ventures	-	27.2	27.2
Net cash flows from operating activities before taxation	(91.5)	300.3	208.8
Inter-company movements	48.9	(48.9)	-
Tax paid	(7.8)	(8.5)	(16.3)
Investing activities	2.2	(118.2)	(116.0)
Financing activities	-	(69.6)	(69.6)
Foreign exchange/other	-	6.7	6.7
Movement in net debt	(48.2)	61.8	13.6
Opening net debt	219.4	(628.8)	(409.4)
Closing net debt	171.2	(567.0)	(395.8)

 

The cash held by the train operating companies at any point in time is affected by the timing of rail industry cash flows, which can be individually substantial. The working capital cash outflow shown above principally arises due to the expiry of the South West Trains franchise and the previously provided for cash losses at Virgin Trains East Coast.

 

The expiry of the South West Trains franchise has increased our net debt in the year by around £30m. We would anticipate a further net cash outflow in this respect as we conclude open matters.  The closing balance of £171.2m for train operating companies shown in the table above excludes South West Trains.

 

The net impact of purchases and sales of property, plant and equipment for the year on net debt ("net capital expenditure") was £100.4m (2017: £157.3m). This primarily related to expenditure on passenger service vehicles, and comprised cash outflows of £111.7m (2017: £155.5m) and new hire purchase and finance lease debt of £27.2m (2017: £47.8m). In addition, £38.5m (2017: £46.0m) cash was received from disposals of property, plant and equipment.

 

Net capital expenditure, split by division, was:

 

	2018 £m	2017 £m
UK Bus (regional operations)	73.8	97.4
UK Bus (London)	2.1	1.6
North America	36.0	37.4
UK Rail	(11.5)	20.9
	100.4	157.3

 

In addition to the amounts shown in the table above, a further net £18.7m (2017: £17.8m) was invested in software and a technology business.

 

Financial position and liquidity

 

The Group has maintained investment grade credit ratings and appropriate headroom under its debt facilities.

 

During the year ended 28 April 2018, we extended the duration of £50m of our committed, bi-lateral core bank facilities by a further year to October 2021.

 

The Group continues to have an appropriate mix of long-term debt enabling it to plan and invest with some certainty.

 

The Group's financial position remains strong and is evidenced by:

 

•  The ratio of net debt at 28 April 2018 to pre-exceptional EBITDA for the year ended 28 April 2018 was 1.2 times (2017: 1.2 times).

•  Pre-exceptional EBITDA for the year ended 28 April 2018 was 9.6 times (2017: 10.3 times) net finance charges (including joint venture net finance income).

•  Undrawn, committed bank facilities of £433.4m at 28 April 2018 (2017: £ 333.8 m) were available to be drawn as bank loans with further amounts available only for non-cash utilisation. In addition, the Group has available asset finance lines.

•  The three main credit rating agencies continue to assign investment grade credit ratings to the Group.

 

Proposed dividend

 

The Board has proposed a final dividend of 3.9p, which will result in a full year dividend of 7.7p per share for the year ended 28 April 2018.  The Board has taken the decision to rebase the dividend to what it views as a sustainable level and which is covered by the normalised, annual free cash flows from the non-rail operations.  The Group will look to at least maintain the rate of annual dividends at that rebased level of 7.7p per share.

 

Approach to dividend policy

 

The Group takes account of its performance, financial position and prospects when setting dividends.  It does not have a prescribed formula for determining each year's dividends and has not set specific targets for dividend growth or dividend cover ratios for the following reasons:

 

·      The Group does not wish such targets to be viewed as a commitment or promise by the Board which, in turn, could act as pressure to pay certain levels of dividend in the future even when at that future point in time, that might not be in the best interests of the Company and its stakeholders.

·      The appropriate pay-out ratio may vary based on many factors including the mix of bus versus rail in the Group's portfolio and factors affecting the outlook that are not reflected in the historically reported figures.

·      Earnings may be volatile from year-to-year. We would look for dividend rates to be more stable and not to fluctuate as significantly as earnings simply to achieve target cover ratios.

As at 28 April 2018, the Company's distributable reserves totalled £211.5m (2017: £247.7m), which compares to dividends paid in cash in the year ended 28 April 2018 of £68.3m (2017: £67.1m). In addition, we consider that the Company's distributable reserves could be further increased through dividends from subsidiary companies and/or changes in the Group structure. The Group considers there to be a low risk that the level of distributable reserves will be a constraining factor on dividend payments for the foreseeable future.

 

The Group has significant undrawn, committed bank facilities as explained in the "Financial position and liquidity" section of this report. The Group considers there to be a low risk that the level of available liquidity / cash resources will be a constraining factor on dividend payments for the foreseeable future.

 

The Directors are focused on maintaining an investment grade credit rating and the three main credit rating agencies continue to assign investment grade credit ratings to the Group. Where the Group was no longer investment grade rated or there was a significant risk of that, the Board would review the dividend policy.

 

Net assets

 

Net assets at 28 April 2018 were £181.7m (2017: £68.5m).

 

The increase in the net assets reflects the profit for the year, actuarial gains on defined benefit pension schemes and fair value gains on cash flow hedges, partly offset by dividends paid. 

 

Retirement benefits

 

The reported net assets of £181.7m (2017: £68.5m) that are shown on the consolidated balance sheet are after taking account of net pre-tax retirement benefit liabilities of £142.2m (2017: £232.5m), and associated deferred tax assets of £24.9m (2017: £44.4m).

 

The Group recognised net pre-tax actuarial gains of £106.7m in the year ended 28 April 2018 (2017: £127.6m losses) on Group defined benefit pension schemes.

 

The Pensions Regulator takes an active interest in the main pension schemes in which we participate and the relevant trustees continue to discuss the appropriateness of scheme valuations and contribution rates with the Regulator.

 

Related parties

 

Details of significant transactions and events in relation to related parties are given in note 19 to the condensed financial statements.

 

Principal risks and uncertainties

 

Like most businesses, there is a range of risks and uncertainties facing the Group.  A brief summary is given below of those specific risks and uncertainties that the Directors believe could have the most significant impact on the Group's financial position and/or future financial performance.  Pages 10 to 14 of the Group's 2017 Annual Report set out specific risks and uncertainties in more detail.  Further information and updates will be provided in the 2018 Annual Report. 

 

The matters summarised below are not intended to represent an exhaustive list of all possible risks and uncertainties.  The focus below is on those specific risks and uncertainties that the Directors believe could have the most significant impact on the Group's position or performance.

 

·      Catastrophic events - there is a risk that the Group is involved (directly or indirectly) in a major operational incident.

·      Terrorism - there is a risk that the demand for the Group's services could be adversely affected by a significant terrorist incident.

·      Economy - the economic environment in the geographic areas in which the Group operates affects the demand for the Group's bus and rail services.  The ongoing negotiation of the terms of the UK leaving the European Union may lead to continuing economic, consumer and political uncertainty.  That may in turn affect asset values and foreign exchange rates, which have a bearing on the amounts of our pensions, financial instruments and other balances.  UK policy following the UK leaving the European Union may affect the UK economy, including the availability and cost of staff.

·      Rail cost base - a substantial element of the cost base of the UK Rail Division is essentially fixed as under its UK rail franchise agreements, the Group is obliged to provide a minimum level of train services and is less able to flex supply in response to changes in demand.

·      Sustainability of rail profit - there is a risk that the Group's revenue and profit could be significantly affected (either positively or negatively) as a result of the Group winning new UK rail franchises or failing to retain its existing franchises.

 

·      Breach of franchise - if the Group fails to comply with certain conditions as part of its rail franchise agreements it may be liable to penalties including potential termination of one or more of the rail franchise agreements.

·      Changing customer habits - There is a risk that changes in people's working patterns, shopping habits and/or other preferences affect demand for the Group's transport services, which could in turn affect the Group's financial performance and/or financial position.

·      Pension scheme funding - the Group participates in a number of defined benefit pension schemes, and there is a risk that the cash contributions required increase or decrease due to changes in factors such as investment performance, discount rates and life expectancies.

·      Insurance and claims environment - there is a risk that the cost to the Group of settling claims against it is significantly higher or lower than expected.

·      Regulatory changes and availability of public funding - there is a risk that changes to the regulatory environment or changes to the availability of public funding could affect the Group's prospects.  New legislation introduced and planned in the UK could see the introduction of franchised bus networks in some areas, which could affect our bus operations.

·      Management and Board succession - there is a risk that the Group does not recruit and retain sufficient directors and managers with the skills important to the operation of the business.

·      Disease - there is a risk that demand for the Group's services could be adversely affected by a significant outbreak of disease.

·      Information security - there is a risk that potential malicious attacks on our systems lead to a loss of data or disruption to operations.

·      Information technology - there is a risk that the Group's capability to make sales digitally either fails or cannot meet levels of demand. 

·      Competition - in certain of the markets we operate in, there is a risk of increased competitive pressures from existing competitors and new entrants.

·      Treasury risks   - the Group is affected by changes in fuel prices, interest rates and exchange rates.

 

Use of non-GAAP measures

 

Our reported preliminary financial information is extracted from the Group's consolidated financial statements prepared in accordance with International Financial Reporting Standards as adopted by the European Union and applied in accordance with the provisions of the Companies Act 2006. In measuring our performance, the financial measures that we use include those which have been derived from our reported results in order to eliminate factors which distort period-on-period comparisons. These are considered non-GAAP financial measures, and include measures such as like-for-like revenue, pre-exceptional EBITDA and net debt. We believe this information, along with comparable GAAP measurements, is useful to shareholders and analysts in providing a basis for measuring our financial performance. Note 22 to the condensed financial statements provides further information on these non-GAAP financial measures.

 

Updating definition of adjusted earnings per share

 

As well as reporting earnings per share in accordance with Generally Accepted Accounting Principles, we also report an adjusted earnings per share measure to help explain the financial performance of the Group. For some years, our measure of adjusted earnings per share has been calculated with reference to profit excluding intangible asset expenses and exceptional items.

 

In our preliminary results announcement of 28 June 2017, we noted our intention to discuss with analysts and investors whether adjusting our definition of adjusted earnings per share to include software amortisation would provide them with a more useful measure of performance, reflecting the growth in these costs as we have invested in our digital programmes. We confirmed in our trading statement of 28 September 2017 that based on those discussions and consistent with emerging market practice, we will now report adjusted earnings per share inclusive of software amortisation. The adjusted earnings per share of 22.3p that we have reported for the year ended 28 April 2018 has been determined on that basis.

 

The effect on previously reported amounts of including these costs within adjusted earnings per share is set out below:

 

Year ended 29 April 2017	Build-up of adjusted EPS	Software amortisation	Revised build-up of adjusted EPS
	£m	£m	£m
UK Bus (regional operations)	121.1	(4.1)	117.0
megabus Europe	(4.3)	-	(4.3)
UK Bus (London)	18.4	-	18.4
North America	19.3	(1.1)	18.2
UK Rail	31.0	(2.5)	28.5
Group overheads and restructuring costs	(18.9)	-	(18.9)
Joint ventures	26.2	-	26.2
Finance costs (net)	(34.1)	-	(34.1)
Taxation	(20.7)	1.4	(19.3)
Non-controlling interest	1.7	0.1	1.8
Profit for adjusted earnings per share	139.7	(6.2)	133.5
	Pence	Pence	Pence
Adjusted earnings per share	24.4p	(1.1)p	23.3p

 

Going concern

 

On the basis of current financial projections and the facilities available, the Directors are satisfied that the Group has adequate resources to continue for the foreseeable future and, accordingly, consider it appropriate to adopt the going concern basis in preparing the condensed financial statements for the year ended 28 April 2018.

 

Current trading and outlook

 

We have made a good start to the year ending 27 April 2019 and have not significantly changed our expectation of adjusted earnings per share for the year.

 

We see positive long-term prospects for public transport.  There is a large market opportunity for modal shift from cars to public transport against a backdrop of technological advancements, rising road congestion and increasing environmental awareness. We have a growth strategy built on continued investment, value-for-money travel and high customer satisfaction.

 

The Group is in good financial shape. Our core debt is committed and in place for over a further three years and we remain investment grade rated.

 

Martin Griffiths

Chief Executive

28 June 2018