Is FirstGroup's (LON:FGP) Dividend Sustainable and Attractive for Income Investors?

For income investors, the sustainability of a dividend is often a litmus test for a company's financial health and strategic discipline. FirstGroup PLC (LON:FGP), a UK-based transport and rail operator, has recently resumed and accelerated its dividend payouts after a decade-long hiatus, raising questions about the durability of its current yield. This analysis evaluates whether FirstGroup's dividend is a compelling proposition for income-focused investors, particularly in light of its short dividend history and recent earnings trends.

A Resurgent Dividend Policy

FirstGroup's dividend trajectory has been nothing short of dramatic. After suspending payouts from 2014 to 2021, the company resumed distributions in 2022 with a modest 0.55p interim dividend and 1.1p final dividend. By 2025, total dividends had surged to 6.5p per share, reflecting a compound annual growth rate (CAGR) of approximately 81% since 2022. This rapid escalation underscores a clear shift in strategy toward shareholder returns, with the company allocating £34 million in dividends and an additional £92 million through buyback programs in FY 2025.

The dividend structure is designed to balance growth and sustainability. FirstGroup targets a payout ratio of around 46% of adjusted earnings, with dividends split roughly one-third interim and two-thirds final. For FY 2025, this translated to a 2.2p interim dividend and a 4.8p final dividend, aligning with its goal of maintaining a 3x cover of adjusted earnings as reported in the annual report. Such a framework suggests a disciplined approach to balancing reinvestment in core operations with returns to shareholders.

Earnings Resilience Amid Strategic Rebalancing

Despite the aggressive dividend hikes, FirstGroup's financial performance in FY 2025 appears robust. The company reported strong growth in its First Bus and First Rail divisions, with the latter poised to generate £120 million in cash inflows over three years starting April 2025. Additionally, First Bus is investing £150 million in electrification initiatives, supported by government co-funding, to future-proof its operations against regulatory and environmental pressures.

However, forward-looking indicators introduce caution. Earnings per share is forecast to decline by 11.8% in the next fiscal year, potentially testing the sustainability of the current dividend trajectory. While the payout ratio remains manageable at 46%, the lack of a long-term earnings history-compounded by the company's recent resumption of dividends-limits visibility into its ability to withstand prolonged downturns.

Sustainability Amid Historical and Forward Risks

The key challenge for FirstGroup lies in its abbreviated dividend history. With only three years of consecutive payouts since 2022, the company has yet to demonstrate its resilience during traditional economic cycles. For context, during the 2020 pandemic, FirstGroup's operations faced significant disruptions, yet the company maintained a cash balance sheet with leverage below 2.0x adjusted net debt to Rail EBITDA, providing a buffer for reinvestment and shareholder returns as detailed in the annual report. This fiscal prudence is a positive signal, but it remains untested in a broader recessionary environment.

Moreover, the projected EPS contraction raises questions about the dividend's near-term viability. While the 3x earnings cover target offers a margin of safety, a sharper-than-anticipated decline in operating profits could force a reassessment of payout levels. Investors must weigh this risk against the company's commitment to buybacks, which added £50 million in shareholder returns in 2025.

Strategic Positioning and Long-Term Outlook

FirstGroup's focus on decarbonization and rail expansion positions it to capitalize on structural trends in public transport. The £150 million investment in electrification for First Bus, for instance, aligns with UK government mandates to phase out diesel vehicles by 2030, reducing long-term operational costs and regulatory exposure. Similarly, the anticipated £120 million cash inflow from First Rail over three years suggests a stable revenue base to support dividend growth.

Yet, the company's reliance on government contracts and subsidies introduces counterparty risk. Any delays or reductions in public funding could impact cash flows, particularly for its rail division. Diversifying revenue streams or securing long-term contracts with fixed pricing mechanisms could mitigate this vulnerability.

Conclusion: A High-Reward, High-Volatility Proposition

FirstGroup's dividend offers an attractive yield for income investors, supported by a rapidly growing payout and a strong balance sheet. However, the combination of a short dividend history, forecasted EPS declines, and exposure to public-sector funding creates a high-risk profile. For investors with a medium-term horizon and a tolerance for volatility, the dividend appears sustainable in the near term, provided the company maintains its 3x earnings cover target and executes its decarbonization strategy.

That said, conservative income seekers may find the lack of historical resilience testing and forward-looking uncertainties too great a risk. FirstGroup's dividend is best suited for those who can tolerate potential cuts in a downturn and are confident in the company's ability to adapt to evolving regulatory and economic landscapes.