Stagecoach Group is facing millions of pounds worth of losses at its rail division after failing to agree terms with the Government for subsidies on the South West Trains rail franchise.

The transport group said in a trading update yesterday that the dispute over the way subsidies are calculated has now been sent to arbitration, adding that its rail unit could face heavy losses if arbitrators rule against it.

“To the extent that these matters are not satisfactorily resolved, the UK Rail Division is likely to incur a significant operating loss in the year ending 30 April 2011,” the company said.

Shares in Stagecoach fell just over 5 per cent to 125.7p a share on the news yesterday morning.

The dispute centres on the terms of the franchise agreement to run South West Trains (SWT) between the south coast of England and London’s Waterloo station.

In the franchise, the Government has agreed to pay a proportion of Stagecoach’s losses if revenues fall below a certain level. But the two sides disagree on when the subsidy payments kick in with the Government claiming it is February 2011 and the transport group arguing it is next April.

The question of entitlement is crucial because rail passenger numbers have fallen by as much as 10 per cent in previous recessions.

Stagecoach’s rivals are already feeling the pinch. Last week, Arriva, the bus and train operator, said it was possible that its CrossCountry rail franchise would need financial support from the Government because of falling passenger numbers.

Steve Stewart, Stagecoach’s head of media and public affairs, said: “We’ve taken legal advice and we consider that we have a strong position.

“This is about honouring the terms of the contract we signed with the Department of Transport, not about renegotiating that contract.”

Stagecoach does not believe that losses on the SWT franchise will tip the whole group into the red.

Arbitrators will also cover the related question of whether revenues from car parks at stations should be included when assessing whether Stagecoach is entitled to the subsidy.

The arbitrator is expected to take up to 18 months to rule in the case and his decision is legally binding.

Stagecoach also said that profits for the full year to April 30 were in line with management expectations. The group has embarked on a cost-cutting programme in an attempt to save £50 million a year. It has booked £12 million of restructuring costs after a redundancy programme.

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