SMRT – CIMB

Out of the dark tunnel

We raise SMRT’s FY17 EPS by 13% to incorporate its higher earnings sensitivity to the new government contracting model for buses, which lifts our DCF-based target price (WACC 7%). Other potential re-rating catalysts are better earnings from cost-control measures. We also suspect that this new bus model is a prelude to a rail financing model. Given further positive news flow expected, we upgrade the stock from Hold to Add.

What Happened

The government is revamping Singapore’s public bus industry to a “government contracting model”, starting 2H14. Under the new system, the government will own all bus infrastructure (depots, buses and systems). Implementation starts only in 2H16 (details overleaf).

What We Think

Better earnings, also cash flow and balance sheet. More details will be unveiled next week with the announcement of the first bus package. SMRT’s Singapore bus business in FY14 contributed S$217.8m in revenue (19% of total revenue) but lost S$28.4m at the operating level. If its operating margins eventually mirror those of bus operators in Australia and the UK, at 10-17%, SMRT’s bus EBIT margin as a whole can shift up to a conservative 7% in FY17 and 12% by FY18, in our estimation, from current negative territory. We are assuming reduced capex spending of 20% for FY16 and 47% for FY17 and asset disposals of c.S$25m in FY17. Net gearing should fall to 27% by then. FY17 EPS could be lifted by 13%, simply from larger revenue contributions and the elimination of bus operating losses.

What You Should Do

Upgrade to Add. Contrary to conventional thinking, we think that the bigger beneficiary should be SMRT, as it is the one with greater earnings sensitivity to the changes. Added to this is a new rail financing framework under discussion, with the earlier-than-expected move on the bus model serving as a prelude to the rail model. All these change our mind on the stock and we upgrade it to Add.

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