When the dust settles, some may look back on the UK government’s response to the coronavirus as slow and defined by inaction and indecisiveness. Those criticisms, however, are unlikely to come from the rail industry.

On 23 March, the first official day of the UK’s lockdown – and after a week of government communications best summed up as ‘advisory’ – the Department for Transport announced it would be initiating Emergency Measures Agreements that would effectively bring train operating companies, which run regional rail franchises, under government control.

This was not some dystopian tribute to what life would have looked like had Jeremy Corbyn’s Labour Party won the election four months previously. Rather, it was an attempt to preserve the finances of the companies that run Britain’s railways in what remains – to the chagrin of airport operators – the most significant UK government intervention in infrastructure in the covid era.

It was, as one industry figure put it to us, an “accidental nationalisation” that suspended the normal financial mechanisms of franchise agreements and transferred all revenue and cost risk to the government. But what about the lessors supplying the TOCs with the rolling stock critical for these services? This industry, as we have previously analysed, has experienced tremendous growth and interest from infrastructure investors in recent years.

As if to underline the stable and secure characteristics that underpin investment in rolling stock companies, or ROSCOs, transport minister Chris Heaton-Harris said in a June statement: “TOCs are continuing to pay the contractually agreed rental cost for rolling stock as they were prior to the Emergency Measures Agreements.”

“This has been a positive for the sector and shows significant government support,” believes Stefan Rose, head of structured finance at Porterbrook, the ROSCO owned by AIMco, Allianz, Vantage Infrastructure and EDF Invest. “In practice, the government has acted as the TOC of last resort to ensure the continuous availability of rolling stock to meet customers’ timetabling requirements. This is positive from a credit perspective.”

“At this stage, it feels like the timetable for delivering trains will suffer the biggest impact, rather than anything more material”
Local Pensions Partnership

The new structure could even be seen as a prelude to future developments. The UK rail industry was facing delays to the Williams review, a government-commissioned report into the sector that was scheduled for publication in autumn 2019. As Darryl Murphy, head of infrastructure at Aviva Investors, which has invested around £2 billion ($2.5 billion; €2.2 billion) in rolling stock, points out: “The Williams review was suggesting the government is increasingly looking towards a different model where revenue risk would be taken away from the TOCs and they would have more of a management contract. That is in effect what has happened.”

Construction complexities

One reason Rose and some of his contemporaries at the other ROSCOs may be feeling positive about the sector in these times is that the bulk of their portfolios are operational – and, in some cases, have been for many years.

However, newer entrants to the sector arrived in recent years with an investment model that involved starting off with lower lease rates, which would then rise after trains had finished their initial terms of six to eight years. The model, pioneered by Rock Rail, has seen interest from the likes of UK pension group GLIL, Aberdeen Standard, Infracapital and DWS. These groups were successful in bidding on newer franchises and, as a result, have more trains under construction.

Bombardier Transportation, the rolling stock subsidiary of the engineering giant, is the owner of the UK’s largest train factory. However, it has suffered from its factories having to operate with reduced staff numbers and social distancing. It also endured a small period of complete shutdown. Other rail manufacturers have also had to contend with similar problems.

Bombardier Transportation has reportedly asked for a government bailout, although this is complicated by the fact the company is undergoing regulatory approval for a €6.2 billion takeover by French transport group Alstom.

GLIL invested with Rock Rail and Aberdeen Standard in 2016 in the rolling stock for the East Anglia franchise – in a deal worth £600 million – with trains manufactured by Stadler. The trio teamed up again in 2017 to deliver rolling stock for the South Western franchise, in a deal worth £1 billion, and with Bombardier trains.

“East Anglia is much progressed in delivering the rolling stock and is being tested and coming into operation,” says Simon Davy, head of private markets at the Local Pensions Partnership, one of the funds that comprise GLIL. “South Western is a little further behind, and I think all construction will be affected by supply chain and labour issues. It’s probably a little early to tell how we see that coming through, but I would expect to see some degree of delays from that. At this stage, it feels like the timetable for delivering trains will suffer the biggest impact, rather than anything more material.”

Aviva was one of the debt providers on both of GLIL’s deals and Murphy remains bullish, despite the disruption.

“There’s strong support behind those delivery contracts,” he says. “We feel comfortable given the challenges.”

However, the single fleet model driven by the market’s newer entrants could leave them more exposed to construction risks than the ROSCOs. Time will tell on how significant the supply chain disruption will be.

Regardless of the methods, the UK rolling stock market has enjoyed considerable growth. Private investment in the sector rose from £661 million in 2015-16 to over £1 billion in 2017-18, though the figure fell to £795 million in 2018-19, according to statistics released last November by industry regulator Office of Rail and Road.

According to Murphy, this does not reflect a decline in interest, so much as a dwindling of opportunity. “Government had been gearing the franchise competitions to incentivise investment in rolling stock,” he says. “That’s been a bit of a purple patch. That was coming to an end last year and actually this year we knew there wasn’t likely to be another new franchise rolling stock procurement for quite some time. That market was pretty much coming to an end.”

An uncertain future

For the stock that has been financed, there remains the chasm that has been exposed in this market in recent years. Older fleets owned by the likes of Porterbrook, Eversholt and Angel Trains are typically protected by the section 54 clause, which guarantees their use by the TOCs. Those financed by newer entrants lack this security. And although it was previously assumed that this stock would be re-leased after its initial term, covid has shrouded this in doubt. The future of travel and office working in the aftermath of the crisis remains uncertain, and while this will not threaten investors in the near term, will we see such a ‘purple patch’ again?

“In 20 years’ time, are all those trains going to be needed on that line?” asks Murphy. “People weren’t probably thinking that we would use significantly less rail than today. The belief was those services would remain fairly consistent. I don’t think we’re in a position to say there is a significant shift away from rail demand. The reality is we just don’t know.”

It is an intriguing position for an infrastructure sub-sector that has offered much in the way of greenfield opportunities. Unlike other sub-sectors, it appears to retain a near-term defensiveness to covid. Beyond that, the future carries a degree of uncertainty.