HSBC maintains Go-Ahead Group 'buy' rating but cuts target price

HSBC maintained its ‘buy’ rating on Go-Ahead Group but cut its target price to 2,200p from 2,475p following a disappointing profits downgrade from the transport operator, although its dividend looks safe and underlying cash generation seems sound.

The bank maintained its ‘buy’ rating as Go-Ahead saying it should generate a broadly stable 6% free cash flow yield from its bus division alone, given that around half is contract backed, and it can also benefit from rail franchise wins and international expansion which is in its infancy.

Nonetheless, Go-Ahead is deemed a limited risk by HSBC, who believes that the range of outcomes for the FTSE 250 company's profits could be plus or minus £15m this year versus its assumption of breakeven.

“At the low point, that would point to a further circa 10% downgrade. But the maximum downside to the group is its share of the £156m contingent liability, or circa 237p per share.”

HSBC said that that cuts to the provincial bus business were “disappointing” and are more relevant to its valuation. An expected £5m cut is driven by £1.5m of insurance costs following accidents, £1.5m from the slowdown in north-east of England and £2m of weakness in Oxford.

“For these issues to emerge so quickly leaves us slightly concerned about the information that management is receiving and/or its willingness to deliver bad news, though Go-Ahead is not alone in the sector in this. We build in only a very limited, fuel driven 2018 profit rebound.”

However, the dividend looks safe to HSBC and should provide support as despite the forecast cuts, the dividend rose 6.5% and a dividend yield of about 5% is the sector’s second highest

Go-Ahead generates about £55m of free cash after all interest charges from bus alone versus a dividend cost of £42m this year, so the bank said it can “comfortably continue growing its dividend, as long as there’s no major reversal”.

Bus profits would have to slide by a further 12% to put the dividend in jeopardy, which HSBC said “seems improbable” as contract-backed London operations account for around half of divisional profit.

Shares in Go-Ahead Group were down 1.7% to 1,967p at 0839 GMT.