Trains and buses and a transport of delight in the City

From ports to railways to roads, transport stocks look poised to accelerate in 2008, while the low-cost carriers will fly the flag for the airlines as the long-haul routes suffer. David Parsley reports on the shares to watch and sees where bidders might park their tanks

In a crowded country, with increasing amounts of legislation to combat global warming, the Government is already investing heavily, and forcing business to invest too, in improved public transport and environmentally friendly freight distribution.

The predictions are that as more widespread congestion-charging schemes and higher fuel prices force a slowing in the growth of car use among the general public, rail and bus operators will benefit with increased passenger numbers.

Along with the move towards more efficient forms of public transport, retailers are relying increasingly on rail freight and local ports to avoid time wasted on congested roads.

RAIL & BUS OPERATORS

Analysts are expecting Stagecoach to be a particularly strong performer in 2008, with many raising their targets for the group following last month's first-half results. Ben O'Toole at Dresdner Kleinwort is predicting that earnings per share at Stagecoach will rise by 11 per cent this year and has raised his share price target to 255p. The shares currently stand at 233.5p and have been rising steadily even in a falling market.

Mr O'Toole says: "We have upgraded our 2008 earnings per share forecast by 11 per cent to 17.2p. The outlook remains very positive and we believe that our upgraded forecasts only partially incorporate the current momentum."

Revenues for the group's British bus operations grew by 8 per cent in the first half and Mr O'Toole says the industry is benefiting from supportive government policies and rising road congestion.

As for rail, on Stagecoach's South West Trains and West Coast services, he predicts like-for-like passenger revenue growth of 15 and 14 per cent respectively, adding that the momentum behind these rises looks set to be maintained during the course of the next year.

In America, Stagecoach looks set to hit its 10 per cent margin target by April 2009 as its Megabus business continues to benefit from restructuring and increasing passenger numbers.

Mr O'Toole is not the only backer of Stagecoach. Analysts at Credit Suisse, Deutsche Bank, Investec and UBS have all upgraded forecasts for the group.

Chris Reid at Deutsche says: "We maintain our 'buy' view on Stagecoach, believing that results should prompt upgrades to the consensus forecasts and that the profit and margin growth here continues to merit a significant premium."

It is a similar story at National Express, the coach giant that also runs the C2C, One and East Coast rail services, and the Gat- wick Express and Stansted Express. Merrill Lynch believes that the group, which has operations in America and Spain along with the UK, is the safest in the sector and has set a price target of 1,390p per share. The shares closed at 1,141p on Friday.

Oliver Neal at Goldman Sachs also has positive things to say about National Express. While warning about the cyclical nature of the rail industry as growth tends to slow when the UK economy slows, he remains upbeat on the group's overall prospects and changed his tip from "sell" to "neutral" last week.

"While we see continuing risks for National Express from an economic slowdown in Spain, the company is relatively less exposed to rail operations than other bus and rail companies, and subsidies on the C2C and One franchises are not set to decline as quickly as those of peers," says Mr Neal. "Given the recent upgrade to earnings guidance, National Express's valuation does not look expensive."

He is even more positive on the prospects for Arriva, which runs buses in London and areas such as Liverpool, Glasgow and Leeds, as well as operations across Europe. It also has the rail franchise in Wales and recently won the CrossCountry line from Virgin Trains.

Mr Neal comments: "We forecast further UK bus margin expansion in 2008 – a function of wage cost control, the lowest year-on-year rise in fuel costs for five years, and continued above-average revenue growth as Arriva benefits from the introduction of the nationwide concessionary-fare scheme. The company is also benefiting from the current strength of the euro versus sterling." Arriva's shares closed at 676p on Friday.

FirstGroup is catching the eye of some analysts too. The company, which runs buses across England, Wales and Scotland and five rail franchises including First Great Western, Scotrail and the TransPennine Express, is on Merrill Lynch's buy list.

The bank has a price target on the recent FTSE 100 entrant of 820p a share. The shares currently sit at 629.5p and have performed well during a turbulent beginning to the year.

But there's always someone at every party that comes along and spoils things. Like the bloke who has had one too many and really should lie down, the rail and bus sector's party pooper is Go-Ahead, currently priced at 2,160p. Goldman Sachs has downgraded the group from buy to neutral.

Mr Neal says: "We now see the argument for holding Go-Ahead shares as evenly balanced. In our view, the company's strong balance sheet and exposure to deregulated bus operations in south-east England remain key positives, but these have to be balanced against its significant exposure to commuter rail and the fuel cost headwind."

While he does find some positive indicators for Go-Ahead, Merrill Lynch is not so diplomatic, saying it is the "riskiest stock in the sector".

PORTS

Since most of the UK's harbours have fallen into foreign hands – witness the acquisition of Associated British Ports by a Goldman Sachs-led consortium in 2006 – only one operator remains as a London-listed company. As such, Forth Ports is creating a great deal of interest at the moment, not least with the news that it may be subject to a bid from Babcock & Brown.

Forth operates nine British ports – Dundee on the Tay estuary, Tilbury on the Thames and seven others in the Forth Estuary in Scotland: Leith, Grangemouth, Granton, Methil, Burntisland, Kirkcaldy and the new Rosyth port. It also has a burgeoning property business and recently revealed plans for 20,000 new homes in Leith, which it will build with joint-venture construction partners.

However, with or without a bid, Forth is expected to perform strongly this year. Even before the takeover rumours began, many analysts had strong recommendations for Forth.

Mark McVicar at Dresdner Kleinwort has a target price set at what would be an all-time high for Forth of 2,430p. The current share price stands at 2,212p even after a week when Babcock & Brown snapped up just over 20 per cent of the company and sparked the takeover rumours.

Whether or not Babcock, or a fund looking to take yet another infrastructure company off the London Stock Exchange, does make a bid for the company Mr McVicar's target price will please Forth's management and shareholders alike. It would also set a fairly hefty bid price should anyone choose to make an attempt to take the group private.

John Lawson, an analyst at Investec, is also bullish about Forth's prospects.

"Forth is delivering strong performance in the ports division and is making good progress in the property arena, recently submitting an outline planning application for the Leith Dock Development Framework," he comments. "We remain convinced of the longer-term value-creation potential in the business."

AIRLINES

Finally, we arrive at the airlines. While the rail, bus and ports groups will benefit from both government investment and a shift in public perception forced by the impact of global warming, the opposite could be true of the UK's major carriers.

Airlines have produced a strong performance over the past three years, but this has been in a rising market and 2008 may be more challenging. They are also expected to suffer from rising fuel costs although, as in the past, they may be able to pass these on to the consumer.

However, there's only so much that the customer can take both in terms of these costs and others, such as green taxes, on both long- and short-haul flights. As a result, it seems British Airways may well be an airline for investors to steer clear of in 2008. Merrill Lynch has a price target of 600p but warns that increasing competition at Heathrow, the completion of Terminal Five, the potential for strikes and BA's exposure to a slowdown in the American economy are all issues of concern. And added to these are the carrier's continued exposure to external shocks such a terrorists attack or even incidents such as that witnessed last week when a BA Boeing 777 crash-landed at Heathrow.

However, low-cost airlines such as Ryanair and easyJet are somewhat insulated from many of the factors that could put investors off BA.

Despite the intensifying competition expected in the low-cost arena, Merrill Lynch believes Ryanair's strong margins and low operating leverage will make it the safest stock in 2008. The Irish carrirer's shares stand at €3.80 (£2.80).

For easyJet, UBS analyst Tim Marshall is predicting a strong year. The group received some good news on Friday afternoon when its takeover of GB Airways was given the green light.

Mr Marshall says: "With the UK market becoming more saturated, easyJet must look to continental Europe for growth. We welcome this move, which we expect will lead to higher average fares given the less developed markets. Costs [staff and airports] will be higher too, but far from questioning Europe as less exciting, we think it holds an attractive future."

UBS has set a target price of 750p, compared to Friday's closing price of 433.75p.

OVERALL PROSPECTS

With an economic storm ahead over the Atlantic, the transport sector presents a mixed bag of stocks. While the long-haul airline business will, it seems, suffer, other stocks are set to benefit, particularly those in the rail and bus sector.

As for takeover activity, Forth Ports is already on the block and observers will never rule out an audacious bid for a weakened British Airways. A more realistic shot for a bid, other than Forth, is the weakest company in the rail and bus pack, Go-Ahead.

There are still dozens of foreign pension groups, sovereign funds and buyout firms in the UK looking to snap up assets on these shores.

While much of the infrastructure has already gone, companies like Go-Ahead represent the next best choice for some. Its weakness may well be its biggest strength in 2008.