Strategic and operating review

Strategic background

Our transport services are part of the solution to the challenges of climate change, levelling up and social inclusion.

We have made further progress in the first half of 2020/21 in the delivery of our business strategy and objectives. We are progressing our change programme to deliver a more agile and efficient business. We have also taken steps to protect the long-term sustainability of the business and the employment we support directly, in our supply chain, and across the wider economy.

While COVID-19 has affected the timeline of some elements of our strategy, we are continuing to explore opportunities to grow and diversify. This includes new commercial products, exploring potential partnerships and maximising the value of our significant estate. We are also progressing new opportunities overseas and are pleased to be shortlisted for several bus contracts in Sweden and Dubai.

We welcome the renewed focus on the importance of bus services by the UK Government and devolved administrations in Scotland and Wales. We are engaging with the Department for Transport around the planned National Bus Strategy for England.  In its recent Spending Review, the UK Government announced further positive investment in bus recovery measures and greener bus fleets.

Our continuing focus remains on providing safe, sustainable, high-quality and good value connections for our customers and we were pleased Stagecoach East Scotland recently won Scotland's Public Transport Operator of the Year award for the second year running.

Strategic objectives and initiatives

Maximise our core business' potential

UK Bus (regional operations)

Our UK Bus (regional operations) business continues to deliver critical links in communities across the UK, supporting the economic health of towns and cities. We are now operating vehicle mileage of around 91% of prior year levels. Customer demand for our regional bus services hit its lowest point around mid-April 2020, during the first UK-wide COVID-19 lockdown, when our commercial sales were as low as 12% of the prior year levels.

From around mid-May 2020, we saw a steady recovery in customer demand with our commercial sales flattening out at a little under 60% of the prior year levels through September and early October.  In the early part of October, we saw commercial sales at around 57% of the prior year and passenger journeys at around 51%. 

As the COVID-related restrictions began to tighten in various parts of the UK from later in October, we saw a sustained softening in demand for the first time since mid-May.  Most recently, our commercial sales are at around 54% of the prior year and passenger journeys are at around 47%.

We are grateful for the measures put in place by the respective governments in England, Scotland and Wales and our local authority partners to protect the continuity of bus services throughout this period. In August, the UK Department for Transport confirmed that payments for the provision of these essential services by regional bus operators in England would continue until no longer required. These COVID-19 Bus Services Support Grant Restart payments are continuing, with an eight-week notice period. The Scottish and Welsh Governments have also extended the periods covered by COVID‑related payments for continuing bus services.

Stagecoach has put a range of measures in place to help customers feel safe and confident in using its services. All our bus, tram and coach services have been accredited with Visit Britain's "We're Good to Go" official mark, recognising the work carried out to meet government and industry COVID-19 guidelines and the processes in place to maintain cleanliness and aid social distancing. The comprehensive regime includes daily deep cleans and contactless payments, in addition to the mandatory use of face coverings.

Since March, we have worked to reduce costs in light of the effects of the COVID-19 pandemic on the business, and to ensure the business is efficient and agile when emerging from the COVID-19 period.  We have identified around £17m of annualised cost savings to date across the Group's entire operations. We have already implemented most of those, and we continue to seek further savings.  In addition, and notwithstanding the actions we took to reduce our 2020/21 planned capital expenditure, we continue to invest in making our business more efficient and effective.  Ongoing initiatives include expanding the functionality of our Green Road connected vehicle technology, enhancing our driver risk management system, the roll-out of real-time passenger counting technology, a new advanced route planning and scheduling system, a new enterprise asset management system and investment in human resources systems.

In August 2020, we launched a new customer rewards scheme with special offers right across the UK in the leisure sector, including visitor attractions, places to eat out and hotels. Stagecoach Rewards provides exclusive discounts to our bus customers and will help support those local businesses in the communities we serve.

Building on the collaborative working during the COVID-19 pandemic, Stagecoach and the wider bus sector is working on a framework with the Department for Transport to ensure bus networks successfully bridge from the current arrangements to long-term commercial sustainability. This Recovery Partnership approach would be put in place when social distancing requirements end, a significant pro public transport message is communicated by Government, and passenger numbers have recovered significantly. Bus operators are in constructive discussions with the Department for Transport about these proposals, and we are committed to playing our part in ensuring a positive roadmap to delivering a long-term sustainable bus sector.

Greater Manchester Combined Authority is currently undertaking a consultation regarding the re-evaluation of its previously announced bus reform proposals in light of the COVID-19 pandemic. The pandemic has had a significant impact on all public transport networks across the country, regardless of how these systems are structured. We believe the best way forward is to build on the strong collaborative working between operators, national and local government during the pandemic to put in place new short-term Recovery Partnerships, followed by similar joint working to deliver the best and most commercially sustainable bus networks for communities for the long-term.

London bus operations

We are pleased with the continued strong operational and financial performance of our London bus business. We continue to work collaboratively with Transport for London in response to the COVID-19 situation, and contract payments are now at normal levels with full service restored.

Rail

We continue to make positive progress in unwinding the affairs of our former train operating companies. Similar to our local regional bus businesses, our ongoing Sheffield Supertram business is receiving government payments for continuing the essential tram services it provides.

Other UK initiatives

We are continuing to seek out new opportunities to diversify the business and create new markets. In July, we launched our Stagecoach Solutions one-stop-shop to help businesses, the education sector and event organisers.  Stagecoach Solutions offers a range of tailored transport solutions. The new product offer, which builds on our core bus services, is designed to respond to the "new normal" and meet the need for flexible mobility services. Stagecoach Solutions offers tailored shuttle buses, education bus services, on demand services and simple corporate travel. It also includes our long established rail replacement business and offers travel support for major events and festivals. Organisations can access services via a dedicated website, stagecoachsolutions.com.

Aberdeen City Council and the University of Kent are among the first organisations to sign up to our newly developed, digital and direct corporate sales platform through a bespoke corporate app. We are looking to focus on business parks and major employers in rapidly growing cities with constrained parking, particularly those with a growing emphasis on demonstrating they are responsible employers. There is also an opportunity to deliver ready-made solutions in areas that may be investigating the introduction of workplace charging levies. We are pleased to have agreed a significant ticketing initiative with NHS Scotland, which employs around 140,000 people at several hundred sites.

We are also exploring potential partnerships and initiatives to maximise the value of our significant estate, including the potential for our extensive depot footprint across the UK as part of logistics networks.

Manage change through our people and technology

People initiatives

At this challenging time, we are focusing our People team resources on our welfare and wellbeing support for our employees, including progressing our employee engagement and recognition programmes. We are also continuing to deliver our industry-leading driver and engineering apprenticeship programmes, as well as planning for the future with further steps to ensure we are an even more agile and customer-focused business.

Simpler ticketing

Stagecoach plans to pilot fare capping using contactless tap-in/tap-off ticketing on bus services in Peterborough in 2021. People making multiple journeys in a day or week would have their payment capped no matter how many journeys they make. We developed a technical solution with our technology partner earlier this year and we now plan to deliver a customer proposition when COVID-19 restrictions are sufficiently relaxed and there is clarity on market conditions.

Across Scotland, we will introduce a new simplified fares structure in January 2021, offering a range of value for money travel opportunities.

Green fleet development

We have set an aspiration for our bus fleet to be 100% zero-emissions by 2035.

Stagecoach is continuing to lead the deployment of cleaner technologies, including hydrogen, electric and hybrid electric buses, having invested more than £1billion in around 7,000 new greener vehicles in the past decade. In September, the Scottish Government awarded £1.15m to the Group to help deliver more than 60 cleaner buses in local communities in East Scotland. We are also continuing to engage with Transport Scotland and the relevant local authorities around the introduction of Low Emission Zones (LEZs) to improve air quality in Glasgow, Edinburgh, Dundee and Aberdeen between February 2022 and May 2022.

A study by Centre for Cities earlier this year suggested that air pollution was the UK's largest environmental risk to public health, producing the equivalent of 40,000 deaths a year nationally.    Modal shift of journeys from car to public transport, as well as investment in greener vehicles, can make a meaningful, positive difference to air quality and health.

Grow by diversifying

As part of our diversification strategy, we are progressing targeted, value-adding opportunities in overseas markets where we see relatively low political/regulatory risk, contracts that offer an appropriate risk-reward balance, and geographies with positive demographics and economic outlook. We were disappointed to be recently informed that our bids for four bus contracts in the Skåne Municipality in the south of Sweden were unsuccessful.  We are, however, continuing with shortlisted bids for two other bus contracts in Skåne.  We are shortlisted for two contracts in the Gothenburg region, with lengths of 10 years and 8.5 years respectively. They involve the operation of around 140 buses, including electric vehicles, from June 2022, and final bids are to be submitted in early 2021. Separately, we are also actively exploring potential bus and long distance coach contracts in the United Arab Emirates.

Financial Review

UK Bus (regional operations)

Financial performance

The financial performance of the UK Bus (regional operations) segment for the half-year ended 31 October 2020 is summarised below:

Our UK Bus (regional operations) business has been significantly affected by the substantial fall in passenger demand for public transport in response to the COVID-19 pandemic.   Nevertheless, the business reported an operating profit for the half-year ended 31 October 2020, with government payments for essential local bus services designed to ensure those services operate at a break-even level.   The payments from government, which cover the majority of our regional bus operations, include amounts in respect of an allocation of finance costs and overheads.   The positive regional bus operating profit should therefore be considered in conjunction with Group overheads and net finance costs, which are separately included in the consolidated income statement.

The reported operating profit for the half-year ended 31 October 2020, also reflects some COVID-related income from government bodies in respect of the prior year to 2 May 2020.  The Department for Transport has now concluded its review of the Group's COVID-19 Bus Services Support Grant ("CBSSG") claims for the twelve weeks from 17 March 2020 to 8 June 2020, without material adjustment to the amount claimed by the Group.  That, and similar reviews of other COVID-related payments, has resulted in an increase in the amount of the payments in respect of prior periods over which we consider there to be sufficient certainty to permit their recognition as income.

Like-for-like revenue decline moderated over the six month period, as passenger demand recovered as some COVID-related restrictions were relaxed.  The significant increase in commercial revenue and customer journeys since May 2020 is despite continuing COVID-related restrictions on our vehicles' capacity to support social distancing, the requirement for passengers to wear face coverings and other COVID-related restrictions.

Like-for-like vehicle miles operated in the first half of the year were 25.0% lower than in the equivalent period last year. Like-for-like revenue per vehicle mile reduced 19.0% and like-for-like revenue per journey increased 60.2%. The reduction in revenue per mile reflects that the COVID-related fall in year-on-year revenue exceeds the year-on-year reduction in vehicle mileage, with government grant payments for continuing bus services.  Revenue per mile can be thought of as the sum of (a) operating profit per mile and (b) operating costs and other operating income per mile.  COVID-related grant income is not included within revenue.  It is reported within operating income, which has resulted in lower operating costs and other operating income per mile than in the equivalent prior year period.  Operating profit per mile is also lower as the government payments for bus services are designed to deliver a break-even position on the relevant services.  The significant increase in revenue per journey is largely attributable to the continuation of concessionary revenue payments at close to pre-COVID revenue rates despite the suppressed concessionary journey numbers throughout the six months.

Like-for-like revenue was built up as follows:

Commercial revenue was significantly impacted by a fall in customer demand in response to COVID-19. At the start of the half-year period, commercial sales across our companies were at around 15% of prior year levels. Over the course of the period, passenger demand gradually increased as some COVID-related restrictions were relaxed, with commercial sales returning to around 60% of the prior year levels. Passenger demand has softened in recent weeks but is starting to grow again, and commercial sales are now at around 54% of the prior year level, which we believe is attributable to the changing pattern of COVID-19 restrictions across the country.
 

The substantial fall year-on-year in megabus revenue partly reflects our decision to suspend megabus services in England and Wales with effect from 5 April. The Department for Transport COVID-related payments for bus services do not cover inter-city coach operations. We have since resumed some services to help reconnect people across the UK.

The decline in revenue receivable from public authorities in respect of concessionary revenue has been more modest, with that revenue generally continuing at around pre-COVID levels despite reductions in vehicle mileage and patronage.

The increase in tendered and school revenue reflects a wider trend of smaller operators exiting the market, resulting in further market consolidation. We continue to work with local authorities to maximise the value for local communities from the financial support councils can provide for socially desirable transport services.

The reduction in contract and other revenue is partly attributable to reduced rail replacement work on the East Midlands railway and Sheffield Supertram networks.  We have continued to operate some profitable contract services for private sector organisations and those are excluded from the government COVID-19 regimes for local bus services.

Outlook

Our outlook for the year ending 1 May 2021 is unchanged from when we announced our full year results in July 2020. The continuing uncertainty of the COVID-19 situation and the UK's recovery makes it more difficult to predict our medium-term financial performance.

We are grateful for the measures put in place by the respective governments in England, Scotland and Wales, and by our local authority partners, to support the continuity of local bus services. In August, the Department for Transport confirmed that payments for the provision of these essential services by regional bus operators in England would continue until no longer required. These COVID-19 Bus Services Support Grant Restart payments are continuing, with an eight-week notice period.  The COVID-19 Support Grant ("CSG") payments for continuing bus services in Scotland have now been extended to cover the period to 17 January 2021.  In Wales, funding has been confirmed for the Bus Emergency Scheme ("BES") for the period to 31 March 2021.

We anticipate that it will take some time for demand for our regional bus services to return to pre-COVID levels, with lockdowns - local and national - impacting on the speed of that recovery. We are therefore planning for a number of scenarios, and are continuing to review our cost base across a range of scenarios.

At the same time, we see positive drivers for the business from a renewed societal focus on health, wellbeing and the environment. We have strengthened our relationship with national and local authority partners in working together through the pandemic to deliver the bus services our customers want. We continue to believe that with partnership working, the delivery of bus services can play a major role in a cleaner, greener and more resilient economy and society, tackling climate change with strong government action to reduce car use.

UK Bus (London)

Financial performance

The financial performance of the UK Bus (London) business for the half-year ended 31 October 2020 is summarised below:

We are pleased with the continued strong operational and financial performance of our London business. As anticipated, operating profit has increased relative to the equivalent period in the prior year, reflecting the benefit of operating the new contracts that we secured in 2019/20. 

The increase in revenue reflects the operation of these new contracts, partly offset by the reductions in vehicle mileage we agreed with Transport for London in response to the COVID-19 situation. We agreed with Transport for London that the contract payments we receive from it would be reduced by the amount of savings in variable costs achieved because of operating less mileage.

The movement in operating margin was as follows:

The main changes in the operating margin shown above are:

·      Other operating income has increased, reflecting grant income recognised under the Coronavirus Job Retention Scheme for employees furloughed as we reduced contract mileage at the request of Transport for London and to protect the wellbeing of more vulnerable employees.

·      Fuel costs have decreased as a proportion of revenue, due to lower hedged prices and better fuel efficiency, largely arising from reduced traffic levels on our routes and vehicle fleet changes.

·      Quality Incentive Contract income has increased £0.8m year-on-year reflecting improved performance against quality targets. 

Outlook

We have worked collaboratively with Transport for London throughout the COVID-19 pandemic, and contract payments are now at normal levels with full service restored. We have agreed changes with Transport for London on how payments of Quality Incentive Contract income are determined this year.  We have also agreed how contract price adjustments are determined on an ongoing basis. Taking account of those changes, we expect that profitability in 2020/21 will be broadly consistent with the prior year financial performance.

We have been encouraged by further contract wins in recent weeks, which will add to our operations in 2021/22.

We note the additional funding provided by the Department for Transport to support the continuation of essential Transport for London services through to March 2021. There are good prospects for the London business and we will maintain our discipline in bidding for new contracts as well as focusing on strong operational delivery.

UK Rail

Financial performance

The financial performance of the UK Rail business for the half-year ended 31 October 2020 is summarised below:

The reported revenue for the prior year period includes revenue at the East Midlands Trains franchise that ended in August 2019.  The substantial fall in reported revenue reflects the end of that franchise.

The like-for-like revenue represents the ongoing Sheffield Supertram business, with the year-on-year reduction principally reflecting the effect of the COVID-19 situation on passenger demand.

The operating profit for the half-year to 31 October 2020 principally reflects positive progress in concluding matters in relation to our former involvement in the UK train operating market. The reported profit also includes the costs of our commercial and business development team, the majority of whose work is on unwinding our former rail franchises and evaluating future opportunities.

Outlook

Our Sheffield Supertram business is receiving payments from government to ensure the continuation of tram services and support their critical role in getting key workers to work as well as ensuring people can access medical care, food and other essentials.

We continue to hold an onerous contract provision, albeit at a reduced amount, for the estimated net costs of fulfilling our contractual obligations at Sheffield Supertram.

Our commercial and business development team continues to explore, and bid for, new opportunities.  We will continue to balance the costs of those business development activities with our assessment of the prospective risk-reward of the available opportunities.

Virgin Rail Group

Financial performance

The financial performance of the Group's Virgin Rail joint venture for the half-year ended 31 October 2020 is summarised below:

Virgin Rail Group's West Coast franchise ran until 8 December 2019. Virgin and we remain focused on concluding contractual matters associated with that franchise, and we have made positive progress in recent months.

Adjusted EBITDA, depreciation and intangible asset amortisation

Earnings before interest, taxation, depreciation, software amortisation and separately disclosed items ("adjusted EBITDA") amounted to £74.2m (H1 2020: £137.4m).  Adjusted EBITDA can be reconciled to the financial statements as follows:

The year-on-year decrease in adjusted EBITDA principally reflects the substantial fall in passenger demand for public transport in response to the COVID-19 pandemic.

Depreciation and software amortisation of £56.1m is broadly in line with the £55.3m for the equivalent prior year period.

Separately disclosed items

The Directors believe that there are certain items that we should separately disclose to help explain the consolidated results.  We summarise those "separately disclosed items" in note 5 to the condensed financial statements and further explain them below.

Non-software intangible asset amortisation

We separately disclose non-software intangible asset amortisation because analysts have told us that they find separate disclosure helpful, a number of our peers separately disclose such costs and the costs generally arise from business acquisitions and/or contract wins.

Non-software amortisation for the half-year ended 31 October 2020 amounted to £Nil (H1 2020: £0.2m).

Re-organisation costs

As part of our response to the COVID-19 situation, the Group has embarked on a programme to deliver a more agile and efficient business. As part of this programme, we have reshaped our cost base by reducing the size of our back-office activities. The restructuring costs, net of related grant income receivable, associated with those changes amounted to £2.8m in the half-year ended 31 October 2020.

Reassessment of onerous contract provision

An expense of £16.5m was separately disclosed for the year ended 2 May 2020 in respect of impairment losses and onerous contract provisions.  As part of that, an onerous contract provision was recorded as at 2 May 2020 in respect of the Sheffield Supertram concession. Since 2 May 2020, the Department for Transport and South Yorkshire Passenger Transport Executive have confirmed their intention to make further COVID-related payments to our Sheffield Supertram business to allow us to continue running essential services. We have recalculated the onerous contract provision, reflecting the benefit of these payments in a revised forecast for the business, and recorded a provision release of £3.6m in the half-year ended 31 October 2020 in relation to the proportion of the provision as at 2 May 2020 that we no longer expect to be utilised.

Discontinued fuel hedges

The Group significantly reduced its vehicle mileage in light of reduced customer demand from March 2020 as the public followed government advice to avoid all but essential travel in light of the COVID-19 pandemic. As a result, the Group significantly reduced its forecast of the level of future fuel consumption that it considered highly probable and discontinued hedge accounting in mid-March 2020 for certain of the fuel hedges covering the period from mid-March 2020 to April 2021.

Amounts previously recognised in the statement of comprehensive income in respect of those now discontinued hedges were transferred to the income statement with effect from March 2020 to the extent that the forecast fuel consumption was no longer expected to occur. The income statement expense for that, and for subsequent movements in the fair value of fuel derivatives that are not accounted for as hedges, has been presented as a separately disclosed item, resulting in a loss of £0.2m recognised in the half-year ended 31 October 2020.

Grant income recognised in the six months ended 31 October 2020 includes amounts intended to compensate the Group for cash payable by it pursuant to fuel derivatives.  To the extent that grant income relates to the fuel derivatives for which hedge accounting was discontinued, and for which the related expenses on those derivatives is reported within separately disclosed items (either in the year ended 2 May 2020 or in the half-year ended 31 October 2020), the related grant income of £6.9m in the half-year ended 31 October 2020 has also been reported within separately disclosed items.

Change in fair value of Deferred Payment Instrument

We received a Deferred Payment Instrument as deferred consideration for the sale of the North American business. The instrument, which is accounted for at fair value through profit or loss, has a maturity date of October 2024 and due to the credit and other recoverability risks associated with the instrument, its carrying value is at a discount to its face value. The Group's exposure to the purchaser of the North American business ranks behind the secured lenders. The carrying value of the instrument was £4.5m as at 2 May 2020. We estimated the carrying value of the instrument to be £2.0m as at 31 October 2020, resulting in a loss of £2.5m recognised in finance costs in the half-year ended 31 October 2020.

Tax

The net effect of separately disclosed items from continuing and discontinued operations was a pre-tax profit of £5.0m (H1 2020: loss of £1.3m). The separately disclosed tax charge of £0.9m (H1 2020: credit of £0.1m) for the half-year ended 31 October 2020 reflects the tax effect of the pre-tax separately disclosed items.

Net finance costs

Net finance costs, excluding separately disclosed items, for the half-year ended 31 October 2020 were £15.7m (H1 2020: £13.0m) and are further analysed below.  The increase in net finance costs is principally due to the higher pensions finance charges arising from the increased pension deficit, in addition to higher interest on increased borrowings.

Taxation

The effective tax rate for the half-year ended 31 October 2020, excluding separately disclosed items, was 25.0% (H1 2020: 19.3%). The increase in the effective rate is principally a function of the low amounts of both the pre-tax profit and the tax expense for the half-year ended 31 October 2020, reflecting the effects of the COVID-19 situation. The tax charge on profit from continuing operations can be analysed as follows:

Cash flows and net debt

The actions we have taken during the COVID-19 situation to protect liquidity and cash flow are reflected in the reduction in consolidated net debt in the half-year ended 31 October 2020 and our continuing, strong available liquidity. 

Net cash from operating activities before tax for the half-year ended 31 October 2020 was £81.3m (H1 2020: £69.9m) and can be further analysed as follows:

Net debt (as analysed in note 16 to the condensed financial statements) decreased from £352.1m at 2 May 2020 to £310.8m at 31 October 2020. The movement in net debt was:

Even after including the significant COVID-related payments received from government, EBITDA and cash flows from operating activities were adversely affected by COVID-19 in the half-year to 31 October 2020 with significantly reduced demand for our regional bus services.  However, our decisions to reduce planned capital expenditure and suspend dividend payments, together with active management of working capital, have assisted us in maintaining strong available liquidity and reducing net debt over the half-year to 31 October 2020.  We would expect to see some increase in net debt over the second half of the year to 1 May 2021, partly reflecting the anticipated part settlement of the net train operating company liabilities explained below.

By the half-year end date of 31 October 2020, all of the major rail franchises previously operated by Group subsidiaries had ended. However, the settlement of the train operating company assets, liabilities and contractual positions continues for some time following the end of the relevant franchises. As at 31 October 2020, the consolidated net liabilities included net liabilities (excluding cash) of £98.5m (2 May 2020: £101.0m) in respect of such items. Accordingly, if all items were settled at their 31 October 2020 carrying values, consolidated net debt would increase by that amount. Consolidated net debt plus outstanding train operating company net liabilities as at 31 October 2020 was £409.3m (2 May 2020: £453.1m)

In addition, the Group receives bus sector COVID-related grant payments on account that are subject to reconciliation and "true up" from time to time by the applicable government authorities.  As at 31 October 2020, the Group has net deferred income of £16.3m (2 May 2020: net receivables of £4.3m) recorded in its consolidated balance sheet, being the net amount of receivables held by some Group companies and deferred income balances held by other Group companies.  The net £20.6m working capital inflow from those payments in the six months is included in the overall £26.3m working capital inflow within the net cash from operating activities before taxation.  We expect the net deferred income balance of £16.3m to unwind over the six months to 1 May 2021.

The net impact on net debt of purchases and disposals of property, plant and equipment, split by segment, was:

Net capital expenditure reconciles to the condensed financial statements as follows:

In addition to the amounts shown in the table above, the impact of purchases of intangible assets was £0.9m (H1 2020: £1.9m). No (H1 2020: £0.1m) cash was received from disposals of intangible assets.

Financial position and liquidity

The Group maintains a solid financial position with investment grade credit ratings and appropriate headroom under its debt facilities.

The Group remains well positioned to navigate this period of increased uncertainty, as evidenced by:

• We have available liquidity of over £850m, and monitor our liquidity and cash flow daily.
• In June 2020, we secured waivers of the net debt to EBITDA and EBITDA to interest covenant tests in our core £325m bank facilities. Those waivers cover the years ending 31 October 2020 and 1 May 2021 and in November 2020, we secured waivers for the year ending 30 October 2021. As things stand, the next testing of those covenants will be in respect of the year ending 30 April 2022. As an alternative to the covenant tests, the Group has agreed with the banks to maintain a minimum level of available liquidity.
• Notwithstanding the covenant waivers, we would nevertheless have complied with the covenants for the year to 31 October 2020.
• The ratio of net debt at 31 October 2020 to adjusted EBTIDA for the year ended 31 October 2020 was 1.8 times (year ended 26 October 2019: 1.4 times).
• Adjusted EBITDA for the half-year ended 31 October 2020 was 4.7 times (H1 2020: 10.8 times) adjusted net finance charges (including our share of joint venture net finance income).
• Two major credit rating agencies - S&P and Moody's - continue to assign investment grade credit ratings to the Group, with rating outlooks at negative.

As at 7 December 2020, our consolidated liquidity position was as follows:

* Excludes (i) foreign currency cash balances, (ii) petty cash balances, (iii) cash in transit and (iv) cash pledged as collateral in respect of liabilities for loan notes

Financial position of the Group

Net liabilities

Net liabilities at 31 October 2020 were £117.2m (2 May 2020: £130.2m).  The decrease in the net liabilities reflects the actuarial gains on defined benefit pension schemes, gains on cash flow hedges and the profit for the half-year ended 31 October 2020.   

Retirement benefits

The reported net liabilities of £117.2m (2 May 2020: £130.2m), that are shown on the consolidated balance sheet are after taking account of net pre-tax retirement benefit liabilities of £404.9m (2 May 2020: £413.1m), and associated deferred tax assets of £76.9m (2 May 2020: £78.5m).  

The Group recognised pre-tax actuarial gains of £6.3m in the half-year ended 31 October 2020 (H1 2020: losses of £87.5m) on Group defined benefit schemes.

The discount rate used to determine pension scheme liabilities as at 31 October 2020 was 1.6%, in line with the discount rate applied as at 2 May 2020, but significantly below prior year discount rates.

The trustees are progressing with the 2020 triennial valuation of our main defined benefit pension scheme, assessing the impact of recent events, but also recognising that the pension benefits payable reflect long-term obligations and investment and funding assumptions. We expect the funding deficit to be substantially lower than the £400.2m (included in the Group total of £404.9m) determined on an accounting basis as at 31 October 2020. We expect that the trustees will conclude the triennial valuation early in 2021, taking into account a range of factors including making judgments on long-term investment returns and seeking to look past current COVID-related uncertainties. At this stage, we would not expect the funding deficit on the main scheme to be less than £100m, and it may lead to an increase in employer contributions over the medium to long-term.

We have seen significant movements in the value of investments and bond yields (which inform the discount rate used to determine the pension liabilities for the financial statements) partly because of the COVID-19 pandemic.  Given the continuing uncertainty resulting from COVID-19, there remains a risk of further significant market movements that could result in significant changes in the amount of our net retirement benefit liabilities reported in the financial statements.  We will continue to look at pensions funding over the longer term and encourage the trustees of the relevant schemes to maintain a long-term perspective on pensions funding.

Related parties

Note 19 to the condensed financial statements provides details of significant transactions between the Group and related parties.

Principal risks and uncertainties

Like most businesses, there is a range of risks and uncertainties facing the Group.  We give a brief summary below of those specific risks and uncertainties that the Directors believe could have the most significant impact on the Group's financial position and/or future financial performance.  Pages 11 to 15 of the Group's 2020 Annual Report set out specific risks and uncertainties in more detail. 

The matters summarised below are not an exhaustive list of all possible risks and uncertainties.  The focus below is on those specific risks and uncertainties that the Directors believe could have the most significant impact on the Group's position or performance. In assessing the Group's likely financial performance for the second half of the current financial year, these risks and uncertainties should be considered in addition to the matters referred to regarding seasonality in note 2 to the condensed financial statements, and the comments made later under the heading "Outlook".

• Major event such as a serious accident - there is a risk that the Group is involved (directly or indirectly) in a major operational incident.
• Economy - the economic environment in the geographic areas in which the Group operates affects the demand for the Group's services.  The ongoing effects of the COVID-19 situation and the negotiation of the terms of the UK leaving the European Union may lead to continuing economic, consumer and political uncertainty.  That may in turn affect asset values and foreign exchange rates, which have a bearing on the amounts of our pensions, financial instruments and other balances.  UK policy following the UK leaving the European Union may affect the UK economy, including the availability and cost of staff.  A weaker economy may also increase the risk of the Group's contingent liabilities, particularly those in relation to its former North American business, crystallising.
• Terrorism - there is a risk that the demand for the Group's services could be adversely affected by a significant terrorist incident.
• Changing customer habits - There is a risk that changes in people's working patterns, shopping habits and/or other preferences affect demand for the Group's transport services, which could in turn affect the Group's financial performance and/or financial position.  It is likely that COVID-19 will accelerate trends of increased home working, home shopping, telemedicine and home schooling. To the extent the effects of that on travel patterns are not offset by modal shift to bus/tram, there will be a longer term adverse effect on the Group's revenue and potentially its financial performance and/or financial position.
• Pension scheme funding - the Group participates in a number of defined benefit pension schemes, and there is a risk that the cash contributions required increase or decrease due to changes in factors such as regulatory approach, investment performance, discount rates and life expectancies.  As explained above in the section entitled "Retirement benefits", given the continuing uncertainty resulting from COVID-19, there remains a risk of further significant market movements that could result in significant changes in the amount of our net retirement benefit liabilities reported in the financial statements. 
• Insurance and claims environment - there is a risk that the cost to the Group of settling claims against it is significantly higher or lower than expected.
• Regulatory changes and availability of public funding - there is a risk that changes to the regulatory environment or changes to the availability of public funding could affect the Group's prospects.  New legislation introduced and planned in the UK could see the introduction of franchised bus networks in some areas, which could affect our bus operations.  The extent to which COVID‑related payments from government continue will affect the Group's future profitability and cash flow.
• People and culture - The is a risk that the Group is unable to attract, develop and retain an appropriately skilled, diverse and responsible workforce and leadership team, and maintain a healthy business culture which encourages and supports ethical behaviours and decision-making.
• Disease - there is a risk that demand for the Group's services could be adversely affected by a significant outbreak of disease.  This was identified by the Board as a principal risk some years ago but the COVID-19 situation is a clear and substantial crystallisation of the risk.
• Information security - there is a risk that potential malicious attacks on our systems lead to a loss of data or disruption to operations.
• Information technology - there is a risk that the Group's capability to make sales digitally either fails or cannot meet levels of demand. 
• Competition - in certain of the markets we operate in, there is a risk of increased competitive pressures from existing competitors and new entrants.
• Climate change - we see public transport as a critical part of the battle against climate change.  At the same time, we recognise that climate change presents a number of risks to the Group.
• Treasury risks - the Group is affected by changes in fuel prices, interest rates and exchange rates.

Auditors' review

For UK companies, there is no statutory or regulatory requirement for auditors to report on interim financial information.  In previous years, we have engaged our auditors to perform a review of the interim financial report for the first half of the financial year.  A review of interim financial information by the auditors is substantially less in scope than an audit and does not provide the level of assurance of an audit.  We consulted with major shareholders on whether to engage the auditors to perform a review of the interim financial report for the half-year ended 31 October 2020.  We and shareholders recognise the importance of reporting the interim financial information on a timely basis.  To help ensure that we published the interim financial information at a similar time to previous years, and recognising that an interim review does not provide the level of assurance of an audit in any event, we decided not to engage the auditors to perform a review of the interim financial report.  The financial statements for the year ending 1 May 2021 will be subject to audit as usual.

Use of non-GAAP measures

Our reported interim financial information is prepared in accordance with International Financial Reporting Standards as adopted by the European Union and applied in accordance with the provisions of the Companies Act 2006. In measuring our financial performance and position, the financial measures that we use include those that we have derived from our reported results in order to eliminate factors that distort period-on-period comparisons and/or provide useful information to stakeholders. These are non-GAAP financial measures, and include measures such as like-for-like revenue, adjusted EBITDA and net debt. We believe this information, along with comparable GAAP measurements, is useful to shareholders and analysts in providing a basis for measuring our financial performance and position. Note 20 to the condensed financial statements provides further information on these non-GAAP financial measures.

Going concern

On the basis of current financial projections and the facilities available, the Directors are satisfied that the Group has adequate resources to continue for the foreseeable future and, accordingly, consider it appropriate to adopt the going concern basis in preparing the condensed financial statements for the half-year ended 31 October 2020.  Although the COVID-19 situation has increased the level of uncertainty facing the Group, we have not identified a material uncertainty regarding the Group's ability to continue as a going concern for at least the next 12 months. Further detail of our going concern assessment is explained in note 1 to the condensed financial statements.

Outlook

Travel in the UK has already recovered significantly since the lows seen in the spring of this year.  While car travel has recovered by more than bus travel, that reflects government messaging discouraging public transport use, temporary constraints on bus capacity to enable social distancing and people seeking to minimise their physical interactions with others during the COVID-19 situation. We have been encouraged by the significant recovery in demand for our bus services since May 2020, even while those factors have applied.

With that evidence of people's continued propensity to travel in the UK, we remain optimistic of rebuilding our bus patronage as the UK emerges from COVID-19.   At the right time, we expect government messaging to switch to actively promoting public transport use. We also expect COVID-related restrictions to be removed in due course.  That and government policy to drive our shared objective of modal shift of journeys from car to public transport sets a positive long-term outlook for buses in the UK.

Furthermore, we are encouraged by the engagement with the UK Government on transitional "Recovery Partnerships" for regional bus services to bridge from the current arrangements to longer term commercial sustainability.  These would help protect bus services as passenger demand and bus operators' profitability recover.

In the contracted London bus market, we are pleased to have won further contracts in recent weeks.  We believe we can build on our current good operational and financial performance, and continue our role in the capital's critical public transport network.

While we expect our business to remain largely UK-focused for the time being, we continue to explore and bid for interesting opportunities elsewhere.  These opportunities have potential to add further value to the Group.

Overall, while it is difficult to predict the precise pace and timing of recovery over coming months, we continue to see a positive long-term future for the Group.

Martin Griffiths

Chief Executive

9 December 2020