Industrials

Chris Bryant is a Bloomberg Gadfly columnist covering industrial companies. He previously worked for the Financial Times.

After completing the sale of its energy business to General Electric, Alstom is now free to focus on its trains. With a new CEO and near to no debt, the French company should act quickly as the rail market consolidates.

Transport Revenue in the Rail Industry
Source: S&P Capital IQ/Alstom

China’s two largest train-makers have agreed to merge, creating a company with more than 25 billion euros ($27 billion) of annual sales, more than twice its nearest competitor. Hitachi of Japan has acquired Italy's AnsaldoBreda and is relocating the headquarters of its global rail operation to London.

Urbanization and environmental pressures are fuelling demand for trains, trams and subways. The market is expected to expand at almost 3 percent a year until 2019, according to European rail industry organisation Unife.

Revenue Growth in the Rail Industry
Source: Unife/Roland Berger

Until now, investors had few opportunities to capitalize on that directly because the biggest train manufacturers were part of larger engineering conglomerates such as Bombardier, Siemens and General Electric.

Alstom has some attractions. The sale of its energy business to GE for 12.4 billion euros will leave it as a specialized train company (albeit one with energy joint-ventures with GE for the time being). Alstom will use some of the proceeds to buy back 3.2 billion euros of shares, about 38 percent of the company's market value. That should provide some support for the stock in the short term.

The maker of the TGV has a 28 billion-euro order book, more than four times annual sales. On Friday, it and Bombardier won a 3.3 billion-euro contract to provide double-deck trains in Belgium. Alstom has good international exposure, with almost 72 percent of order coming from outside Europe in the year through March 2015. It's recently won contracts in India and South Africa, and expanded its technology portfolio with the purchase of GE's signalling arm.

In the medium term, the company is targeting organic sales growth of 5 percent and an operating margin of between five percent and seven percent.

That's a good starting point, but Alstom needs to watch its back. The merger of CSR and CNR acquisition creates a new Chinese train giant. China's rail ambitions were underscored last month by a $1.6 billion contract win in Hungary. This suggests competition for contracts and pressure on margins will increase.

Alstom, which will be left with essentially zero net debt after the share buyback, need not be passive observer of industry consolidation.

CEO Patrick Kron, who thwarted Siemens' effort to combine the two company's train businesses in 2014, will step down after the buyback. He will make way for Henri Poupart-Lafarge, a former French civil servant who's worked at Alstom for 17 years.

Even so, pulling off a deal with a large competitor such as Siemens or Bombardier would be challenging for antitrust reasons and the risk that a deal would trigger mass job cuts.

Smaller acquisitions might therefore make more sense: Europe still has several independent train and rolling stock companies including CAF and Talgo in Spain and Stadler Rail in Switzerland. Alternatively, Alstom could supplement its signalling business, potentially by acquiring assets from Thales.

Analysts at Morgan Stanley note that European train markets are becoming less fragmented as the EU imposes common standards on operators across the region. And a larger company can spread development costs over a higher revenue base.

But rail remains a project-driven business, and orders can be volatile. Alstom should make the most of its plump order book and lack of debt -- and get a bigger train set.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Chris Bryant in Frankfurt at cbryant32@bloomberg.net

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Edward Evans at eevans3@bloomberg.net