Credit crunch could be fatal for franchises

The next few months are going to be a nerve-wracking time for rail operators and their parent companies. With the credit crunch quickly turning into a possible recession, there will be widespread fears that the healthy annual growth rate of 5-6 per cent on which they have depended to make profits for the past few years will suddenly evaporate.

If that happens, then quite quickly several franchises could get into financial trouble, and that in turn would lead to problems for government as well. However, so far, the opposite is the case. Stagecoach and National Express have both reported very healthy profits over the past few weeks – admittedly covering periods that ended early this year – and all the immediate signs are that the railways are still experiencing growth.

There are two contrasting trends here which make analysis particularly difficult. On the downside, rail passenger numbers are very closely related to the overall performance of the economy. Indeed, the growth of recent years has been stimulated by the constant rise in people’s real incomes as well as by other factors outside the industry, such as growing congestion. Therefore, a significant downturn will have an immediate impact on the number of people taking the train.

On the other hand, the increase in fuel prices will attract people onto the railways. Rail managers are already reporting that there has already been an impact of the fuel crisis with people beginning to realise that, at times, the railways can represent a real bargain compared with taking the car. The number of bus passengers has also risen recently, a reversal of a long term trend.

As an aside, this shows how easy it would have been for the government to begin to attract more people to public transport and get them out of their cars. During most of the past 30 years, since the last big oil price rise, the cost of motoring has fallen in relation to public transport fares, most notably bus tickets which are unregulated, and it is hardly surprising that more people have chosen to use their cars. It is extraordinary that it has taken the fuel price crisis to enable a Labour government to boast that bus usage outside London is going up for the first time since it took office!

So the big question is this: will the increase in rail users as a result of the fuel price crisis be more significant than the loss in numbers as a result of the recession. Despite the public optimism from Brian Souter, the head of Stagecoach, and other industry figures, my guess is that the bubble we are experiencing at the moment in terms of increased numbers will burst soon. I suspect that Souter, privately, is less buoyant. What else explains Stagecoach’s remarkable decision to cut back on ticket office opening hours at the same time as announcing higher profits in its rail division? If managers were expecting numbers to continue rising, surely the company would not feel the need to make such mean-minded economies which have not only angered passengers but seem designed to ensure that South West Trains will lose revenue.

The key reason for suggesting that the railway companies face a hard time is the level of employment. The economics of the railways are heavily dependent on commuters going to work and on business trips that result from people needing to travel for work. Both these are likely to be hit over the coming months if we experience even a brief downturn in the economy, let alone a serious recession. Not only will there be fewer people traveling to work, but with fares going up above the rate of inflation, as the government has stated they will, there will be pressure on people to use videoconferencing instead of travelling to meetings which will reduce the numbers in those all-important first class coaches. Those above inflation rises will ensure that all means of travel are more expensive, which means companies will increasingly question their employees’ need to travel.

If the recession does begin to bite, the railway will quickly degenerate into a state of crisis, dragging in the government as well as the train operators. The train operators will start finding it difficult to meet the large premium payments agreed in the recent franchise deals but will be unable to extricate themselves as pulling out of one franchise would lead to the loss of all their other ones, according to the Department for Transport’s rules.

The private operators would be able to withstand losses for a year or two but they would quickly throw the towel in if they thought the recession was going to be a prolonged one and there was no way of recovering their losses. The impact of a recession would be softened slightly by the fact that franchises let since 2005 all have profit (or loss) mitigation arrangements which means the risk is shared with the Department.

However, that may not be enough to save the day. Remember, it took only one bad year to bring down Sea Containers’ GNER contract, a collapse that was caused by the 7/7 bombings 2005, together with a couple of other factors such as, ironically, the reduced compensation payments from Network Rail as a result of better performance. Sea Containers were able to hand back the keys because the company did not have any other franchises but now nearly all them are held by companies with more than one such as Stagecoach, National Express, First and Arriva.

The Department has stated clearly that if will not renegotiate these franchise arrangements, whatever happens. In fact, that has already been shown up to be untrue because, behind the scenes, considerable changes to the First Great Western franchise were agreed by the Department after the chaos in the early days of the contract in 2006 which was caused by the specification being too tight.

However, the Department would have to stand firm if one of the major groups attempted to renegotiate all its deals. And that would precipitate a crisis in the franchise arrangements. If several franchises suddenly appeared on the market all at once, there is no doubt that premium payments would be reduced. While on the face of it, the railways are booming, in fact the whole house of cards could come tumbling rapidly along with the economy if the recession bites.