Land Transport – OSK DMG

Positive Paradigm Shift

The Land Transport Authority (LTA) introduced the new bus operating model last night. The details have yet to be finalized and financial impact remains uncertain at this point. We opine positively towards the move as it creates a sustainable operating environment. For the two local incumbent operators, we expect them to enjoy profit boost going forward, from year 2016 to 2020. We continue to favour ComfortDelGro.

A gradual transition. The cost-plus model will kick start when the operating licenses for the two existing operators expires on 31 Aug 2016. Initially, only about 20% of the buses would be tendered out publicly (tender open to foreign operators e.g. Veolia, Keolis) for a five year operating contract with two year extension possibility. The remaining 80% of buses will continue to be operated by the two incumbents under the new model (ie contractual price to be negotiated).

Going asset light. Under the new model, LTA will assume ownership of all the us operation assets. This implies that at certain point of time, LTA will buy over the existing assets from the two local operators. As of the end of 2013, ComfortDelGro’s bus operating assets were recorded at around SGD827m book value whereas SMRT’s was estimated at about SGD250m. However the lack of details makes it difficult to ascertain the actual financial impact. We think the positive impact on ComfortDelGro will be much larger than on SMRT.

Earnings boost for both operators. We expect both ComfortDelGro and SMRT to be better off from year 2016 to 2020 even if they were to lose the first open tender since they have been barely profitable under the existing model. In our opinion, the contractual price (to be negotiated) for this five-year grace period under the new operating model is likely to lift both incumbents’ EBIT margins closer to 8% which is the industry norm, in turn lifting their profits.

Upgrade sector rating to Neutral; Prefer ComfortDelGro. In view of this positive news we upgrade the sector rating from Underweight to Neutral and raise our fair value estimates for both ComfortDelGro and SMRT respectively to SGD2.60 and SGD1.17. However, we prefer the former for its strong track record of operating under the cost-plus model which potentially leads to higher chance of tender wins as well as better operating margins.

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