Should bond investors worry about defaults?
The number of voices predicting a recession are growing. The UK economy contracted in the first...
Great Britain’s railways consist of 2,566 stations, 15,847km of route and employ around 240,000 people^. But over recent months, passenger numbers have dwindled to almost nothing, as people were urged to ‘stay at home’.
According to Network Rail, footfall was down 93% at some of London’s busiest stations at the height of the crisis. Even today, with restrictions lifted, fewer services are running and, if social media posts are anything to go by, some stations remain all but deserted, even at rush hour.
So which train-related companies are the fund managers backing to get through the global downturn and prolonged ‘working from home’ scenario? Those helping combat climate change for starters.
ASI UK Ethical Equity* fund has a holding in Trainline*, the digital ticketing platform. Manager Lesley Duncan, said: “Structural trends are generally supportive for Trainline. Governments globally are investing in rail to combat environmental and congestion issues and infrastructure investments in high-speed rail will make long-distance train journeys a more credible alternative to short-haul flights.
“Adoption of on-line e-ticketing is another structural tailwind for Trainline, with adoption levels in the UK and Europe currently below other transport types such as low cost air carriers; Trainline’s technology enables this switch to occur. Finally, Europe is potentially opening up with signs that the European market will de-regulated which creates an opportunity for Trainline to create its UK model in this market.”
Ben Griffiths, manager of T. Rowe Price European Smaller Companies fund, which also owns the company added: “We believe that the business is well placed for the ongoing shift to online and paper-less travel ticketing in rail and coach markets, underlying market growth in the UK and overseas and regulatory developments. The business has been very adversely affected in the short term by the economic and policy consequences of the pandemic. But this is a strong management team, and they have taken appropriate steps in terms of costs, liquidity and strategic initiatives to ensure that it is well placed for an eventual recovery.”
Kames Ethical Cautious Managed fund has three train-related companies in its top five bond holdings: Network Rail, Transport for London and Deutsche Bahn.
It’s managers commented: “We invest in these names as they remain well rated entities with strong government support for their long term investment programmes, which support both national and local passenger and freight travel. These credits are generally key to national initiatives on improvement to climate change and air quality and to meet long term targets such as the Paris Agreement.
“Network Rail is trying to develop its networks and facilities to increase sustainability through upgrading station designs to include, for example, rainwater harvesting, water saving taps, extra insulation and solar panels. They are also trying to increase biodiversity along routes and increase the re-use of waste materials.
“Transport for London continues to pursue a number of sustainability goals to make the London transport network greener – monitoring vehicle emissions and dust and air quality at Underground stations. Under the current London Mayor, it has a “Healthy streets and healthy people” strategy aiming to achieve 80% of journeys to be made by walking, cycling or public transport by 2041 and improve London’s air quality with initiatives including the Ultra-Low Emission Zone and Low Emission Bus Zones.
“Deutsche Bahn has also been investing in sustainability for a number of years and has set a number of targets to achieve a greener outcome. It is targeting CO2 neutrality by 2050 (with 50% by 2030 and all electricity from renewable sources by 2038). It is already recycling 95% of raw materials and is now targeting noise levels. Altogether they have 150 measures to protect the climate, nature and resources and to reduce noise.”
Aside from Deutsche Bahn, there are, of course, other opportunities overseas. M&G Corporate Bond fund for example, has SNCF Reseau in its top ten**, which upgrades and sells access to the French rail network, serving all passenger and freight rail companies.
The M&G team commented: “We own different bonds issued by SNCF Reseau in sterling, with maturities ranging between 8 years (the 2028 bond) and 40 years (the 2060 bond).
There are a couple reasons why we like these bonds: Firstly, the fact the company remains fully supported by the French state. Despite the current situation and the anticipated changes to the French railway sector, which will slowly result in greater competition, the linkage between the company and the French state remains very strong. For example, the planned €35bn debt relief and continued access to the Caisse de la Dette Publique (Public Debt Fund) for liquidity purposes.
“Second, the fact that valuations look attractive is also a driver behind our exposure: SNCF Reseau trades with a spread over UK gilts of about 1% (depending on the maturity profile) which for a key French-state owned infrastructure company looks attractive. Also, according to Moody’s, the company has a slightly better credit quality than the UK government: both are rated AA, but the UK government has a negative outlook.”
In contrast to these positive views, Montanaro European Income manager George Cooke, sold GetLink – the company that readers will know as Euro Tunnel – after lockdown began. It had the most stretched balance sheet in the portfolio and George felt that, in light of the hit to passenger numbers, lower earnings could force a covenant breach, depending on how things played out. “I’m not allergic to risk,” he said, “but as soon as there are question marks I’ll seek to exit.”
He tells us more about this decision in a recent video interview.
Japan enjoys some of the most advanced and well-maintained infrastructure on the planet and the country is famous for its high-speed bullet trains, which have been serving the country for more than 50 years and are renowned for their blistering speed and ‘to the second’ punctual service.
Japan’s passenger rail network is also the busiest in the world, carrying almost 30% of global rail passengers (more than all of Europe combined). Privatised in 1987, six passenger rail companies were created with JR East, JR Central and JR West being the three largest.
The managers of First State Global Listed Infrastructure have a number of Japanese train-related holdings. Before lockdown they commented: “We like Japanese passenger rail companies for their high barriers to entry, strong free cash flow and predictable earnings.
While they have underperformed in recent months, the managers have stuck with West Japan Railway and East Japan Railway. “As fixed cost businesses with relatively slim margins, these companies are proving sensitive to lower volumes,” they said. “Demand has begun to return for their conventional railway lines. However, passenger numbers on their longer haul, high-speed shinkansen routes (which provide a similar function to local airline routes) are taking longer to recover, reflecting lingering concerns of coronavirus risks.”
^Source: Department for Transport, Rail Factsheet, December 2019
*Source: FE Analytics, full holdings list, 30 June 2020
**Source: fund factsheet, 30 June 2020