My post on Stagecoach last week reminded me of a company I remember having looked at late last year - Rotala (LON:ROL) , a small cap bus operator in the UK. It's a refreshing company, probably because its services are immediately understandable and obvious to us - the business model is relatively simple, and the economics underlying it is no great mystery either. I figured I should give Rotala another look, both since I enjoyed looking at Stagecoach and because I had one big refrain - I thought the type of business this was was probably rather prohibitive to the little guys.
On that note, I found a nice report produced for the Government in 2010. These often give a feel behind the economics of an industry, and are usually pretty interesting reading. Among other things, it discusses the barriers to entry for smaller players - mostly financial and logistical, as you'd expect, and the average returns of the big 5 bus players in the UK.The edge
If Rotala have an obvious advantage over their larger competitors, then, it's the growth one. The magic of free market creative destruction - or whatever you want to call it - serves to see smaller companies tending to grow significantly faster than their larger competitors over any reasonable period of time. Rotala have grown revenues by 57% over the last 3 years; though improvements in operating profit haven't quite kept up. Operating assets haven't increased by nearly as much, either. Fuel costs and a reduction in the level of Government support have contributed to the worsening margins, so the potential for reversion there is debatable. Perhaps, if fuel costs stabilise, Rotala will be able to start bumping margins back up over time.
Along with small-cap size often comes a relatively cheaper price, as well, in earnings or asset terms. This is clearly a benefit, but in some part is simply a reflection of the greater risks inherent in holding a company which isn't a huge and entrenched market player. Rotala is clearly cheaper than Stagecoch, for instance, though again I'm oversimplifying; Stagecoach have a far wider remit than Rotala does.The downside
Frankly, though, in bus operators more than most I can see scale advantages. Transport just lends itself to size, as does the regulatory system. Rotala don't earn fantastic returns on capital (though they are stable), and the reduction in government support is likely to keep their profits subdued this year. If anything, I wonder if government support is likely to become even less supportive and not more in the future, too - in that document I linked, the authors noted that the big 5 bus operators all earn above their cost of capital, some significantly. In the simplest and most blunt terms, this might suggest the government is oversupporting the industry, and in times of budget cuts, the appearance of subsidisation in a profitable industry isn't likely to go down too well.
Judging by their pre-close trading statement, things are unlikely to have improved at Rotala this year:
""Given the industry conditions created by central government policies, we believe that the Company produced an acceptable performance in 2012"
Broker forecasts have profits down below last year's levels for the next 3 years, though the company is spending on acquisition. Given the above, though, I'm sort of on two minds regarding acquisition - half of me likes the logic; they're buying bus operations contiguous to its main areas of operation, which should improve efficiencies along the whole chain. At the same time, I wonder if First's disposal of a significantly loss-making depot is just indicative that it's not a good place to be. Can Rotala really run it that much more better?The big question
I suppose it's not too much of a stretch to suggest that if Rotala can carve out a solid regional monopoly - they're currently second biggest provider in the second biggest region, the West Midlands - they can bump up returns. I think the government situation is a big risk factor, though - I shy away a little from any industry which receives government support, since I equate it with the assumption that the company should never earn over the cost of capital.
It does strike me as a safe company from a financial point of view. Cash flow is strong, and given the relatively short life of assets (short compared to buildings, at least), the company has flexibility with regard to cash by changing replacement policy on aging assets. I'm just not convinced it has any real edge over the market or its competitors. It might grow, but it doesn't look like a compounding machine earning ~8% returns on its capital.