Land Transport – MayBank Kim Eng

Imminent Changes To Bus Operating Model

Current bus model is not sustainable; Tender system a possibility. With stagnating bus fares and rising cost from inflationary pressure, the two existing operators have been running loss-making operations for years. Under a business model that is financially unviable, we believe that SMRT and SBS Transit, a subsidiary of ComfortDelGro, would be reluctant to renew their bus licences when they are due in 2016. Hence, a change to the bus model is imminent, in our view, in favour of a tender system to award packages of service contracts. We believe that the Land Transport Authority (LTA) is currently evaluating the merits of a tender system, as evident from the tender system used to award service contracts since the start of the year.

Tendering system would likely reverse losses – upside to profits. In the near term, switching to a tender system will be positive for the Public Transport Operators (PTO), as losses at their bus units will reverse. The future profitability of the bus business would depend on the bids placed during tenders. Our analysis suggests that our profit estimates for next year would be raised by 18-22%, if the PTOs retain their current market share and their bus units achieve a 10% margin under the new business model

Key negatives for PTOs under new system. It appears that under a tendering system, the PTOs will be able to reverse losses and turn profitable. So what is the catch? We caution that there are at least three areas that would be negative for the two existing operators under a tender system: heightened competition, higher cost to ensure better service standards and shorter service contracts.

Net effect should still be positive for existing PTOs. While competition from new entrants would pose a threat, we believe that existing operators would still have an edge over new entrants with their scale of operations. Even if the existing operators do concede market share, their profitability under a tender system would still be an improvement over their current loss-making operations.

Sticking with current calls: BUY CDG, SELL SMRT. While switching to a tender system is positive for both PTOs, we maintain our preference for CDG over SMRT. We believe that our forecasts for significantly higher gearing at SMRT over the next few years will be reflected in lower stock valuations. Furthermore, PER valuations for CDG are relatively more attractive under various bus margin scenarios on a tender system. Reiterate BUY CDG, SELL SMRT.

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