National Express Group Plc ($NEX)

Roadkill

National Express (NEX) has 100% upside from its current share price because:

1. Its debt is higher than normal, but sustainable

2. Its earnings have taken a hit from Covid but are recovering

3. It is undervalued vs historic valuation and on an absolute basis

1.     NEX’s debt is sustainable

NEX has £1.7bn of net debt, including the perpetual hybrid instrument of £500m issued during Covid, putting it at around 6x my estimation of normalised EBIT or 10x 2022 EBIT.  This compares with an average of around 4.5 to 5x pre-Covid.  I believe NEX’s debt is sustainable because:

a)     NEX’s hybrid instrument, with a 4.25% coupon, grants NEX a non-reciprocal redemption option at the 5^th and 10^th anniversaries, and annually thereafter. This instrument is subordinated and carries no covenants.  Excluding it, debt/normaliased EBIT is 4.2, in line with historical averages;

b)    NEX’s covenant debt/EBITDA ratio is 2.8x at 31.12.22, inside its existing covenants, which revert to 3.5x EBITDA as of June 2023, having been relaxed during Covid to 5x.  Furthermore, this 2.8x figure is on NEX’s 2022 EBITDA figure, which has not returned to (higher) normalised levels;

c)     Of NEX’s £1bn bonds, £600m mature in 2027-28.  The remaining £400m bond matures in 2023. NEX has already agreed a bridge-to-bond facility with a term of 36 months that provides it immediate liquidity and flexibility to time a new issue;

d)    NEX is a bankable business, given the contractual underpinning and inflation protection in its revenues.  Only 25% of its revenues has outright passenger risk (mainly UK bus) and 85% of its contracts has inflation protection, with roughly half having full cost protection and the other half linked to CPI.  Among other factors, this explains the interest from infrastructure funds and pension funds in its businesses;

There is also additional downside protection.  First, the margin of safety in the valuation is such that even if an equity injection were required to support a refinancing, there would be still be upside to the current price.  But also, NEX’s businesses are divisible and attractive to financial buyers, with recent transactions in North American school bus and UK bus providing valuation support.  For example, a sale of the North American school bus and transit business would generate £1.5 billion based on the multiple EQT paid for First Group’s comparable business, all but eliminating total debt and leaving UK bus and Alsa trading at 5x pre-Covid earnings based on the current share price of 117p.

2.     NEX’s earnings took a hit from Covid but are recovering   

NEX operates schools buses, private shuttle services to offices, city and regional bus services and long distance coach.  All of these were disrupted by Covid and all have been affected to varying degrees by inflation.  Driver shortages in the USA have suppressed earnings but these are easing now.  The UK operations continue to be affected by strikes.  However, these are short term impacts to the business.  NEX’s business is an extremely stable one over time, with consistent revenues and operating margins across the cycle.  It also should continue to grow given the longer term trend of urbanisation and public transportation use.

3.     NEX is undervalued

NEX generated £300m in operating profit in 2019.  It is on its way back to this figure now as it recovers inflation with double-digit revenue increases across its businesses.  It has disclosed that it expects a £12m increase interest on its £400m bond maturing in 2023, which implies an interest rate of around 5.5%, consistent with the current market price of the 2023 bond.  If we assume refinancing at this rate for the debt maturing through 2028, this yields around £100m of annualised interest and with tax at 25%, we are left with £150m of net profit, which gives a 5x p/e approximately at the current share price of 117p.  This compares to a p/e of around 12-13x pre-Covid, with leverage at a comparable level.  A 20% equity yield is also very cheap on an absolute basis for a company with NEX’s earnings profile and that in the 10 years to 2019 grew operating profit at a 9% CAGR while paying out around 50% of earnings and holding leverage levels constant.