Moving forwardsGroup Chief
Executive’s Review
Looking at National Express today, I see a business that is being transformed from the one that I joined at the beginning of 2010. Twelve months ago, we set out a two year Business Recovery programme to restore business margins. We said that we would achieve cost reductions, restore the business to a sound foundation and drive forward our performance to deliver value for our shareholders.
I am pleased with the progress we have made so far.
We have:
- delivered margin improvement by embedding cost management and operational excellence across the Group;
- established a sound financial foundation;
- continued to focus on cash generation; and
- started to make selected investment to drive future value creation.
We are ahead of our plan – and in 2011 we will complete our Business Recovery programme. But our plans do not stop there. Beyond improving our business to industry standards, we have a strategy to deliver industry leading performance, organic growth and, in time, new market opportunities. We are leveraging our unique geographic footprint across all modes of public transport, together with our Group-wide synergies. Despite the economic challenges that we face, we are creating a stronger business to deliver future value to shareholders.
This is a renewed company. Our much improved financial performance provides a platform to drive further growth, continue targeted investment and restore a dividend. With a clear focus on our strategy we are confident in the year ahead.
2010 – Delivering margin improvement
Our focus in 2010 has been to restore margin performance. Through cost control, fare yield management and a focus on delivering operational excellence across the business, Group normalised margin rose from 5.9% in 2009 to 9.6% in 2010. Normalised operating profit increased over £44 million to £204.2 million (2009: £159.8m), while normalised profit before tax rose 38% to £160.5 million (2009: £116.2m). Excluding rail operations, normalised profit before tax reached a record level in 2010. We are rebuilding a high quality business, uniquely focused on public passenger transport expertise in international markets.
Cost management and operational excellence
The immediate priority in delivering an improved margin has been controlling cost. Our North American operations have led the way, delivering over US$30 million of annualised cost savings by simplifying the business, driving operational excellence through local service delivery, and instilling a clear cost management culture. This has been about focusing our school bus business back onto basics – delivering excellent customer service, safely, at the right cost. A new highly experienced North American management team has steadied the ship, ensuring that the Business Recovery programme has remained on target and achieving a 44% improvement in normalised operating profit to US$57.1 million (2009: US$39.6m). It also secured 22 new contracts in a successful bidding season, whilst retaining over 90% of its own contract portfolio, delivering cost efficiencies to budget-constrained school board customers.
Spain was already performing strongly as we entered 2010. Against a challenging domestic economic backdrop, ALSA has achieved strong margin growth and a normalised operating profit exceeding €100 million (2009: €85.7m), testament to its flexible and robust business model and the stable regulatory environment. Cost efficiency has driven this improved performance, with lower fuel costs supplemented by running 2% fewer kilometres. Spain also returned to revenue growth – urban income grew by 9%, with resilient city council revenue boosted by a new contract in Agadir, Morocco. Intercity revenues grew in the fourth quarter of 2010 for the first time since the third quarter of 2008.
Improving yield management
Driving margin through improved yield management has turned UK Bus from one of the worst performing operations in the industry to one of the best performing within the space of 12 months. Normalised operating profit increased 48% to £28.3 million (2009: £19.1m excluding the disposed Travel London business). By rebalancing fares between cash tickets and travelcards, we have improved the revenue mix and managed the bus network more effectively. We are now investing in new fleet. Cost reduction was also a key aspect of improved performance in 2010 – we reduced the number of depots, restructured pay grades and improved engineering efficiency. Our UK Bus business is an excellent asset with a strong footprint. It has catchment areas with high population density and opportunities to better meet future passenger needs. With the management team now strengthened, I am sure we will be able to achieve further progress.
Driving margin through improved yield management has turned UK Bus from one of the worst performing operations in the industry to one of the best performing.
After strong profit growth in 2009, UK Coach consolidated its position in 2010. Underlying revenue grew by 3% year-on-year, but additional investment saw the margin decrease, from 14.1% to 12.8%, as we invested in marketing, new facilities and in tactical promotional campaigns. Our strong brand and unique business model present opportunities to deliver revenue and profit growth over the medium term. Innovation is key to achieving this. In 2010 we rolled out telematic traffic management and driver safety systems that will improve the passenger experience, and during 2011 new systems and customer service applications will further support financial performance. A new senior management team is driving this change.
Opportunities in Rail
Our goal in Rail has been to move beyond the difficulties of 2009 and ensure that National Express is positioned to participate in profitable future rail operations where risks are both appropriate and manageable. We are delighted that we have secured extensions to both of our current rail franchises; we expect to operate National Express East Anglia until February 2012 and c2c until May 2013. We continue to deliver superior customer service and performance – c2c remains one of the most punctual franchises in Britain – whilst we are leading the industry’s investment to reduce commuter overcrowding, in partnership with the Department for Transport (“DfT”).
Targeting industry leading margins
Our business improvement plans are well underway. We continue to focus on delivering margin improvement through reduced cost. North America is now achieving an 8% operating margin and we aim to achieve double digit industry-leading margins by the end of 2011. This will be a challenge, but the highly competitive, budget constrained market offers both issues and opportunities. We will deliver the remaining US$10 million of our Business Recovery programme through the application of GPS technology and centralised procurement. Our UK Bus business is already delivering an industry average margin but we will continue to optimise the network and drive revenue growth to take us towards industry leading performance. We will deliver our remaining business improvement goals in 2011, to achieve strong returns across all our operations.
Creating a higher quality business for the future
n addition to delivering much improved margins, 2010 was also the year in which we resolved a number of historic legacy issues and created a platform for a higher quality business in the future. We also completed the rebuilding of our capital structure – to the extent that the Group is seen increasingly as one of the best financed in the sector. Two bond issues in January 2010 and June 2010 raised £575 million at attractive rates, alongside a £500 million refinancing of our bank facility in July. Consequently, the Group now has long-term committed funding in place until between 2014 and 2020. In addition, the Group has ample facility and covenant headroom.
We have been successful in resolving a number of areas where there has been potential for volatility in profit or in cash generation. We have negotiated a settlement of all outstanding UK corporate tax issues with HMRC, under which the Group will settle £17 million in outstanding liabilities over the next four years, compared with a potential liability of approximately £50 million. This excellent outcome has resulted in a one-off benefit of over 6 pence per share to non-normalised basic earnings per share (“EPS”) in 2010. We have also now closed the Group/UK Coach pension scheme in the UK and agreed a deficit funding plan which should see the scheme be self-sufficient in six years. We have reached agreement with the DfT under which both parties have dropped all claims relating to the East Coast franchise exit. We have significantly reduced the Group’s future exposure to self- insured incident costs and we have negotiated an exit settlement from National Express’ long-held shareholding in Inter-Capital and Regional Rail Limited, which had exposed the Group to heavy losses for many years. Together, these settlements have given us certainty over future cash commitments. In addition, in resolving these legacy issues, the Group is committed to minimising future exceptional operating costs.
These actions should reduce overall future volatility and ensure that EPS growth is more directly linked to operational success and that free cash generation is more stable. This has supported our proposed restoration of the dividend, with a final payment for 2010 of 6 pence per share fully supported by our non-rail earnings and free cash flow. Importantly, a foundation has been established from which we can develop and grow the business.
Nobody will try harder for our customers than we do.
A framework for development
With a stronger management team in place and a clear focus on delivering consistent operational excellence, we are now achieving significantly improved business performance, with better margins and returns. During 2011, we will move to the next phase of our strategy, further enhancing shareholder value creation.
We are focused on three key areas of improvement:
Structure – we have flattened our organisation structure and shortened the decision-making process, whilst embedding clear, quantitative key performance metrics. For example, the three UK businesses now report directly to me as Group Chief Executive, removing two previous management layers;
Investment in key development areas – we have invested in new talent through 20 core appointments. The five divisional heads bring over 130 years of mass public transport experience between them. With our talent development framework, we are building the capability to manage existing and developing operations. We have specific teams now focused on driving down global procurement costs and identifying new strategic opportunities for the future; and
Culture – we are creating one common culture, with a shared vision and values, and we have improved our performance- based incentive framework.
With a stronger management team in place and a clear focus on delivering consistent operational excellence, we are now achieving significantly improved business performance, with better margins and returns.
Our vision is to earn the lifetime loyalty of our customers by consistently delivering excellent value, frequent, high performing mass public transport services.
We have adopted a common set of values across National Express to deliver our vision:
Safety – more than anything else, we value the safety of our customers and our employees. Nothing we do is worth getting hurt for and we will not do anything which risks causing harm. We have launched a major internal programme, ‘Driving Out Harm’, which is designed specifically to educate and instil a safety-first culture at all levels and across all parts of the Group. Employee remuneration is now increasingly aligned with safety performance;
Customers – we place customers at the heart of our business. Nobody will try harder for our customers than we do, particularly when things go wrong. We are working to improve our customer service; for example, we are strengthening our contact centre in Birmingham to provide 24/7 advice to our UK Coach customers if they are stranded or concerned about their travel plans;
People – we behave towards all our employees with the respect and dignity we expect from others. We will strive to enable all our people to reach their full potential and to give their best as individuals and in teams. Our employees are core in enabling National Express to consistently deliver high performing services of which we can be proud. Our new innovation programme, ‘Make A Difference’, has brought groups of employees from all levels of the business together to drive improvement. For example, our UK Bus ‘Routes2Excellence’ scheme has combined the views of customers, drivers and staff to produce an innovative route learning scheme for drivers; and
Community – we are proud to operate in many international communities. Our policies and practices will advance the social, environmental and economic conditions of those communities. I am delighted that our flagship coach station in Birmingham was the first public transport station to achieve the BREEAM standard for environmental performance.
A diversified international portfolio
We have a diversified portfolio of bus, coach and rail businesses operating in international markets. Some of the key strengths of this portfolio include:
Market leadership – in most of our markets we have strong or exclusive positions and compete primarily with other forms of transport, such as the car or plane. We are market leader in West Midlands bus and have a 60% share of the UK scheduled coach market with our National Express brand;
Market knowledge – we have a deep understanding of and expertise in managing regulated concessions, which provide price protection, service exclusivity and stability. In Spain, our long-term concessions provide an ‘order book’ of 7.2 years;
Relationships – we have extensive experience in managing long-term contractual relationships. In North America school bus, our contracted order book is 4.1 years;
Quality international assets – National Express uniquely benefits from a balanced exposure to the UK, Spain and North America, in bus, coach and rail. This portfolio provides a balance – economic growth, political environment and regulation can all vary. For example, recent uncertainty over UK government funding in UK Bus has been offset by benefits in our Spanish and North America businesses. These high quality assets offer access to many mass transport opportunities, as many countries move to liberalise their markets; and
Cash generation – our businesses balance cash generation with capital investment. Whilst North America school bus is capital intensive, for example, UK Rail uses limited capital. We are able to reinvest surplus cash in areas that generate higher returns.
Strategy
Our strategy will develop the unique attributes of this business
portfolio in three stages:
- 1 Margin growth – we will continue what we have started – margin growth in the existing business through an unceasing focus on revenue and cost management:
- •Revenue management – we will continue to optimise yield management (for example, in UK Bus and Coach), create new services and ways to access the market, and focus on building customer retention; and
- •Cost management – we will eliminate unnecessary operating costs, optimise our route networks, drive better procurement, remove unnecessary management layers and utilise technology to improve efficiency.
- 2Organic growth – we will target volume growth in our existing markets, by offering better products and services which our customers want to buy and by winning new bid opportunities across our bus, coach and rail markets. We have returned to underlying growth in Spain, where there are also a number of new bid opportunities. We believe we can grow the UK Coach business and we will seek to participate in profitable future UK Rail operations under the new, longer term franchising regime;
- 3Bolt-on acquisitions – over time we will target opportunities to acquire operators which fit with our existing businesses in the same modes and geographies, and which quickly add scale and synergies to the existing operations. We will apply strict return criteria to ensure that any acquisition adds shareholder value. For example, in December 2010, we completed a US$13.3 million bolt-on school bus acquisition in New Jersey, USA, which offers strong geographic fit to our existing adjacent operations.
Operating cash generation remained strong and represents 109% profit conversion.
In the longer term, we will look at selected opportunities to grow in both existing and new geographies and take advantage of liberalisation and continued privatisation of mass public transport markets. Our experience in different regulatory regimes could allow increasing value creation as Continental European and other markets are opened up to competition. We have set up a small Commercial Development team with significant international public transport experience to explore such opportunities. We will undertake any such expansion in a measured way and only where we bring clear competence and expertise to leverage the opportunity, adopting a disciplined approach to capital allocation and a clear ‘Return on Capital’ model to ensure shareholder returns are delivered.
In delivering our strategy, we will focus on achieving superior long- term returns on investments in excess of our cost of capital. The Group’s pre-tax return on capital employed (“ROCE”) increased in 2010 to 13.2% (2009: 10.7%) and we are targeting to improve this to 15%.
Our strategy will be built around offering excellent value for money prices, frequent services and pleasing our customers. To our bus, coach and rail customers, excellent prices must be a cornerstone of our strategy and therefore our cost base must be lean. Through our unique market position and by ensuring that nobody tries harder for our customers, I believe we have excellent opportunities to drive value creation and deliver strong returns for our shareholders.
Excellent opportunities to drive value creation.
Outlook
Following our strong performance in 2010, we have continued to see good margin progression and revenue growth into 2011. Our cost improvement plans are proceeding, with particular focus on North America and UK Bus, and investment in improved customer services in UK Coach is now underway. Spain continues to deliver a strong performance, with limited adverse impact from the domestic economy, and improving volumes in Intercity travel. UK Rail is performing as expected and we will strive to renew the East Anglia franchise when it is tendered later this year.
2011 will bring a number of challenges, with tough economic and fiscal conditions prevailing in most markets. Increased fuel duty and reduced concessionary income in the UK is expected to impact us by a net £10 million per annum from late 2011 onwards. We are developing plans to offset this adverse effect. We are hedged for fuel usage through 2011 and beyond. With the foundation firmly in place and a clear focus on delivering our strategy, we expect to continue to perform well during the year ahead, whilst building for future growth.
Monitoring our business
The Group is managed using a set of key performance indicators that monitor delivery of performance improvement and ensure that capital is allocated in a disciplined way to support our longer term objectives. The KPIs are set out on pages 2–3.
2010 saw positive progress in all but two of our financial KPIs. Underlying revenue growth returned in most businesses, despite reducing mileage operated in several businesses, and should improve as the Group targets organic growth from improving economic conditions. Strong growth in normalised profit before tax reflected the delivery of margin improvement. Normalised basic EPS declined, however, due to the partial impact on 2009 EPS of the Rights Issue.
Cash generation is a key objective for the Group. Operating cash generation remained strong and represents 109% profit conversion, building on 2009, when low investment and one-off working capital reductions drove a very strong cash performance. As a result of better profitability and cash generation, the Group’s debt gearing ratio continues to improve, achieving 2.1 times debt in 2010.
Our non-financial KPIs provide key passenger, network and safety measures. The total mileage operated continued to reduce whilst passenger numbers across most divisions increased, improving our operating efficiency and environmental impact. Similarly, we grew the number of routes we operate in North America, improving revenue.
Our employee lost time injury rate improved or was broadly unchanged across our different businesses and, in rail operations, the number of signals passed at danger declined. The number of preventable vehicle accidents also improved. Further improvement in our safety record is a priority and is the focus for our new ‘Driving Out Harm’ programme.
Further information on our financial KPIs is set out in the Performance and Financial Review.
Dean Finch
Group Chief Executive
24 February 2011
