2Q FY10 results: strong rental and non-operating income cushioned CCL losses

• Net profit surprised on the upside, helped by better rental and nonoperating income: 2Q FY10 net profit of S$52.8MM (+24.1% Y/Y) was significantly above expectations, bringing 1H10 net profit to S$101MM. This strong set of results was helped by robust rental and non-operating income from maintenance and related contracts.

• Train ridership growth slowed, CCL losses prevail: Ridership was up by a mere 2.2% for the quarter even after incorporating CCL Stage 3 contribution. Operating profit of the train segment was 7% higher, attributed to the non-operating income contribution of S$8.5MM. Stripping that out, operating profit of the train segment actually declined 16% Y/Y. This translates into an estimated loss of S$6MM for the CCL this quarter, in line with our loss estimate. Stages 1 & 2 will open in 1H CY10 and Stages 4 & 5 in 2011.

• Rental business prospects exciting: Operating profit from the rental business increased 10.8% on the back of increased rental space and better yield. The company will refurbish three more Xchanges in FY11 and FY12 – Jurong East (+2,500sqm), Orchard (+1,600sqm) and Esplanade (+2,000sqm), potentially increasing the lettable space by another 20% in the next two years. Rental now accounts for 21% of total operating profit and looks set to increase going forward.

• First foray overseas set to go: SMRT completed its 49% acquisition of Shenzhen Zona. The associate will start contributing in 3Q10. Management expects Zona’s profit after tax in 2010 and 2011 to at least more than double the Rmb24MM in 2008, based on existing fleet size alone, due to lower interest expense. Management expects Zona’s profit contribution to be material in five years’ time.

• Maintain Neutral, raise Dec-10 PT to S$1.90: We raise our earnings estimates by 23%/24%/27% for FY10/FY11/FY12 to incorporate the potential rental contribution from the three new refurbished Xchanges, fare reversion post-June 2010 when the current fare reduction expires, as well as associate earnings contribution from Zona. As a ersult, we increae our Dec-10 PT to S$1.90.

Lower energy costs boosted margins

2QFY10 results above expectations. 2QFY10 registered net profit of SGD52.8m, up 24.1% YoY (+9.5% QoQ), or 31.4% of our full year forecast. The variance was due to lower staff costs which fell 1.1% compared to our forecast of +10.4% as well as the 16.9% decline in energy cost. Operating profit rose 20.1% YoY boosted by MRT (+7%), bus (+272%) and retail rental (+11%). We raise our FY10 net profit by 9% to S$183m from S$168m while maintaining our TP at S$2.00.

Ridership growth still sluggish; stronger growth expected in FY11. Between Jan-Sep, SMRT’s daily rail ridership rose a mere 3.2% YoY to 1.42m. We are, however, upbeat that ridership figures could be stronger next year on the back of stronger economic and tourism growth. The Circle Line will be fully operational in 2011, which will be the gateway to the two Integrated Resorts. We forecast rail ridership growth of 4% in FY10 and a stronger 10% in FY11, in anticipation of positive spin offs from these resorts which will radiate tourists and locals alike towards these locations.

Higher operating expenses expected in 2HFY10. Management cautioned that 2HFY10 profitability will be impacted by the 11% increase in electricity tariff which has been contracted for the period between 1 Oct 2009 and 30 Sep 2010. Apart from higher energy costs, management expects operating expenses to rise due mainly to more scheduled repairs and maintenance, and higher staff and related costs as headcount is expected to be higher with the operation of Circle Line Stage 3, increased train runs and recruitment of bus service leaders.

At its lower range of its 14-20x trading band. SMRT currently trades at ~14x FY10 P/E multiple which is at the lower range of its 14-20x trading band. We view SMRT as an ideal switch play for investors with a defensive mandate, given the 7-month market surge. SMRT has a low beta of 0.45x and strong earnings resilience underpinned by a firmer economic outlook. At our TP of S$2.00, SMRT will trade at an FY10 P/E multiple of 16.5x, a reasonable peg in our view. An interim dividend of 1.75¢ per share was declared for 2QFY10.