FirstGroup's Open Access Expansion: A Strategic Bet on Rail Liberalization and Profit Growth

The UK rail sector is undergoing a seismic shift. With the creation of Great British Railways (GBR) and the ongoing nationalization of passenger services, traditional rail operators are navigating a complex transition. Yet, amid this upheaval, FirstGroup—a global transport giant—is doubling down on open access rail as a disruptive, high-margin, and scalable asset class. For investors, this represents a compelling opportunity to capitalize on a sector poised for growth, even as regulatory and market risks loom.

The Open Access Model: High Margins, High Stakes

FirstGroup's open access operations, including Lumo (London-Edinburgh services) and Hull Trains (Humberside-London routes), operate on a starkly different financial model compared to its franchised services. According to internal data, open access units generate 16% profit margins, translating to £37 million in annual profits, while franchised services like Avanti West Coast and Great Western Railway yield a mere 3% margin, despite contributing £3.6 billion in revenue. This disparity underscores the profitability of open access: operators bear full investment and operational risk but retain all profits, a stark contrast to the heavily regulated, subsidy-dependent franchised model.

The scalability of open access is equally compelling. Lumo's “Lumo Class” low-cost service has added 6 million new rail journeys since 2021, outpacing traditional operators in market expansion. Meanwhile, Hull Trains has demonstrated operational flexibility by scaling to ten-car trains on congested routes. These operations thrive in a fragmented, demand-driven market, offering services that cater to underserved passengers and air travelers seeking affordable alternatives.

Rail Liberalization and the GBR Challenge

The UK government's push for rail liberalization, while promising, introduces uncertainty. GBR's creation—a vertically integrated public entity managing both infrastructure and passenger services—risks distorting competition. Critics warn of a “margin squeeze” scenario, where GBR could undercut open access operators by leveraging its control over fares and infrastructure costs. For example, if GBR subsidizes fares below cost on key routes, it could drive open access competitors out of the market, stifling innovation and scalability.

However, FirstGroup's strategy appears designed to mitigate these risks. The company has actively lobbied for GBR to retain an independent regulator (the Office of Rail and Road) and to enforce fair access rules for non-GBR operators. By advocating for a regulatory framework that prioritizes competition, FirstGroup aims to preserve its open access operations as a counterbalance to GBR's dominance.

Strategic Positioning and Future Prospects

FirstGroup's open access expansion is not just about profitability—it's about capturing growth in a sector where demand is rising. The UK's rail liberalization agenda, despite nationalization, still emphasizes the need for competition on long-distance routes. FirstGroup's planned services to Stirling, Carmarthen, and beyond align with this vision, positioning the company to exploit underserved corridors. Additionally, the government's £15.6 billion investment in transport projects offers opportunities for FirstGroup to bid on city-based rail contracts, diversifying its revenue streams.

Yet, the path forward is not without hurdles. Network Rail's congestion warnings and the Office of Rail and Road's controversial approvals of open access applications (e.g., Grand Central's ten-year extension) highlight the sector's regulatory volatility. Investors must weigh these risks against FirstGroup's demonstrated ability to navigate complexity. The company's CEO, Graham Sutherland, has emphasized resilience, noting that FirstGroup's open access units are “engineered for agility in a rapidly changing landscape.”

Investment Thesis: A High-Conviction Bet

For long-term investors, FirstGroup's open access operations represent a high-conviction opportunity. While the franchised model is increasingly unattractive due to low margins and political risk, open access offers a scalable, high-margin alternative. The key risks—GBR's potential monopolistic tendencies and regulatory shifts—are manageable, given FirstGroup's proactive engagement with policymakers and its focus on cost efficiency.

A critical factor will be the outcome of the Railways Bill and GBR's final structure. If the legislation includes safeguards for open access (e.g., independent regulation, transparent cost accounting), FirstGroup's valuation could see upward momentum. Conversely, a regulatory environment favoring GBR at the expense of private operators could dampen returns.

Conclusion: Balancing Risk and Reward

FirstGroup's open access expansion is a strategic bet on the future of UK rail. By leveraging high margins, operational flexibility, and a fragmented market, the company is positioning itself to thrive in a post-nationalization era. While regulatory risks persist, FirstGroup's proactive approach to policy engagement and its track record of innovation suggest it is well-equipped to navigate the transition. For investors willing to tolerate short-term volatility, this is a compelling opportunity to invest in a sector where disruption and profitability go hand in hand.

Investment Advice: Consider a long position in FirstGroup, with a focus on its open access subsidiaries. Monitor developments in the Railways Bill and GBR's implementation timeline. Diversify exposure to mitigate sector-specific risks, but prioritize FirstGroup's ability to adapt in a rapidly evolving regulatory environment.