January 21, 2016

Domestic decline drives DB strategic rethink

Written by  Keith Fender
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GERMAN Rail (DB) is one of the world's biggest transport organisations with nearly 297,000 employees (64% of them in Germany) and group turnover of around €40bn in 2015. Yet despite its size and breadth of activities, DB faces an uncertain future - largely driven by changes in its "home" market.

DB has historically made much of its profit from German rail activities, with two business areas - regional transport (DB Regio) and infrastructure management (DB Networks) contributing disproportionate levels of overall profits. In the first half of 2015 DB group operating profits were reported as €890m on turnover of €20bn. DB Networks represented 42% of the profit but only 22% of group turnover, while DB Regio accounted for 29% of profit and 21% of turnover. DB group net debt rose by €1.4bn in the year to June 2015 and now stands at €17.6bn. Investments in infrastructure and new passenger trains account for most of the increase.

 

DB Networks benefits from around 75% of all capital investment made by DB group and much of this is co-funded by German regional and national governments, sometimes with contributions from the EU. Significant network enhancements are planned in the next five years such as the completion of the Erfurt - Nuremberg high-speed line and the Stuttgart 21 project. DB Networks increasingly provides access to non-DB operators as DB Regio has failed to win substantial contracts in several parts of Germany.

Passenger numbers reached a record high in Germany in 2014 but DB is operating fewer of the trains. In the first half of 2015 DB Regio won just 27% of the train-km tendered - the corresponding figure in the first half of 2014 was 74%. Contracts awarded in the second half of 2015 largely went to DB Regio's competitors, although DB has retained the first Berlin S-Bahn contract to be tendered.

Moves by regional governments to establish rolling stock leasing companies or underwrite third party fleet ownership has eroded DB Regio's historical advantage in being able to finance and provide new trains. Furthermore, DB's higher cost base means that new entrants such as Britain's National Express and Go Ahead have been able to offer costs per train-km at around half the historical DB Regio rate.

Toxic mix

DB inter-city passenger services have been hit over the last 18 months by a toxic mix of competition from start-up long-distance bus operators, poor reliability, and strikes - all of which has caused passengers to look elsewhere. To its credit, DB plans to respond by launching new services, new trains and a wider range of fare options with the intention of growing the market over the period to 2030.

IC2Railfreight unit DB Schenker Rail has suffered a decline in volumes and in the first half of 2015 made a €74m loss. This is largely the result of structural changes which also affect many European railfreight operators, such as the decline in coal usage and the slowdown in the Chinese economy, which is affecting both German exports and the global steel industry, leading to lower railfreight volumes in Europe.

DB's mishandling of the long series of strikes in Germany organised by the GDL union in 2014-15 negatively impacted its freight and long-distance passenger business - with competitors and substitutes benefiting.

From a profitability perspective DB is rapidly becoming a (fairly lightly) regulated but disproportionately profitable utility comprising DB Networks with two German rail passenger businesses, where profits are being squeezed by new entrants, alternate business models, and substitution by other transport modes.

Built up by acquisitions over the last two decades, DB's activities outside Germany are profitable but financing investment in them is made more difficult by DB's overall cash position and the desire of the company's owner, the German federal government, to focus investment on Germany. DB announced in 2015 that it was considering part-privatisation of both DB Schenker Logistics and DB Arriva. Both of these companies were privately owned before DB bought them and both generate consistent profits so could be attractive to institutional investors.

Without new sources of capital, it is unlikely DB can significantly expand the footprint or activities of either Arriva or DB Schenker Logistics. The loss of profits from the reduction in DB-operated regional trains in Germany will be partly offset by the need for less investment in new trains and depreciation costs for these fleets.

DB has embarked upon a review of strategy led by a small team at its headquarters, assisted by consulting firm McKinsey. This DB2020 review is expected to lead to changes in services, for example further reductions or complete cessation of overnight services and potentially part-privatisation for Arriva and other subsidiaries. DB may decide to go further than it has previously indicated and sell DB Networks subsidiary DB Energy. This is a profitable business and its counterparts in Poland and Italy were privatised in 2015.

As IRJ went to press on December 16, the board of DB was due to decide on aspects of the strategic review, indicating asset sales and privatisation could come sooner rather than later.

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