Tough Year Ahead

• 1Q11 revenue was up 9.0% y-y to S$235.3m, net profit down 20.7% y-y to S$38.2m

• 1Q11 results were slightly below our expectation

• Downgrade our price target to S$2.18 from S$2.36

• Maintain Hold rating as SMRT is fully valued at this point of time

1Q11 results were slightly below our expectation

1Q11 revenue was up 9.0% y-y to S$235.3m, while net profit was down 20.7% y-y to S$38.2m. 1Q11 revenue was slightly below our expectation due to much lower maintenance revenue while other segments were within our estimates. Operating expenses were within what we have forecasted and we expect operating expenses to increase 5.5% in FY11E. Operating profit and net profit were down 20.2% and 20.7% to S$46.1m and S$38.2m respectively, due mainly to higher operating expenses. We think that the performance for the previous year (1Q10) is quite exceptional due to the low costs operating environment and stimulus from the government.

Advertising and rental segment continue to support its bottomline

Both the advertising and rental businesses continue to do well benefitting strongly from the improving economy, contributing about 38% to 1Q11 operating profit. These 2 segments with its high operating margin of 66% and 78% are likely to do well for the rest of the year. Advertising will benefit from the upcoming major events while rental will benefit from the addition of rental spaces from refurbished train stations and new circle line stations.

Outlook and estimates for the rest of FY11

We are lowering our revenue and net profit estimates by 2.2% and 6.8% respectively, to reflect the challenging operating environment and lower revenue from its maintenance arm. Circle Line daily ridership of 145,000 was way below the breakeven target of 200,000, and is expected to operate at a significant loss until stage 4 & 5 opens in 2011. Average fares could also be impacted by the implementation of distance fares from July’10.

Valuation and Recommendation

We are maintaining our Hold recommendation and cutting our fair value estimate to S$2.18 to reflect the below than expected ridership for Circle Line and lower revenue from its maintenance arm. SMRT will likely be impacted by higher electricity and labour costs for the rest of the year with an improving economy. SMRT is currently trading at 19.9X FY11E earnings, which is 19.8% higher than its historical average of 16.6X. We think that the share price for SMRT is fully valued at this moment, and we are advising investors to stay on the sidelines until we see an improvement in the performance of circle line. We derived our fair value using the DCF model and the model is based on a risk free rate of 2.78% and 1% terminal growth.

We are maintaining our Hold rating and downgrading our fair value estimate to S$2.18 from S$2.36.

Just As Well

• Net profit fell worse than expected 20.7% in Q1 ended Jun ’10 to $38.24 mln (or a more moderate 7% if year ago’s $7 mln exceptional item were excluded), as higher costs (largely related to the opening of Phase 3 of the Circle Line) could not be matched by rail ridership on the new line, which came to 145,000 average a day, vs management’s expectation of up to 200,000 a day.

• What is also likely to dampen enthusiasm in the stock, which hit an all-time high of $2.33 (on Jul 5 ’10), is management’s warning of more of the same in the remaining quarters of the current fiscal year ending Mar ’11. Management does not expect profit for ye Mar ’11 to match the previous fiscal year’s $162.9 mln. The key reason again is the Circle Line. (Note: 5 stations on the Circle Line commenced operations on 28/5/09, followed by 11 on 17/4/10. The remaining 13 stations will open next year.)

• We do not however expect this to affect the dividend payment, which was raised by 0.75 cent to 8.75 cents per share for ye Mar ’10, costing $128.97 mln and representing 79% payout, vs 72% for ye Mar ’09.

• At $2.22, yield would be 3.9%, which should provide some cushion as the share price heads lower in the near term.

• We recommend BUY on Weakness. At say $2, yield would be 4.4%.

Curse of the Circle

• 1Q11 plunged 21% yoy; below expectations due to higher costs despite higher ridership

• FY11F cut by 6.5%; expect street to cut more given optimistic estimates

• Market overlooked near term humps with shares trading close to peak PE of 21x. Maintain Fully Valued, TP cut to S$1.88

1Q11 plunged 21% yoy, below expectations; FY11F cut by 6.5%. 1Q11 results came in below our expectation (6% below consensus on our original FY11F forecasts). We have cut FY11/12F earnings further by 6.5%/4.0% on higher operating costs, coupled with slower-than-expected ramp up in Circle Line (CCL) ridership growth. We believe street estimates may be lowered by a larger magnitude given higher estimates.

Revenue +9%; expenses up by a higher +13% = PBIT down 20%. 1Q11 revenue grew 9% yoy to S$235.3m on higher MRT/bus ridership, rental revenue, partially offset by lower revenue from Palm Jumeriah Monorail. Expenses grew by a higher 13% on staff costs (+10%), electricity & diesel (+29%) and others (+19%). EBIT margins dipped 7.2ppt to 19.6%.

CCL ridership of 145k/day is below target of 200k/day; losses to continue. Average ridership on Circle Line is c.145k/day with the commencement of Stage 1&2 from 17 Apr, but this is below the 200k/day ridership originally expected. Management expects the line “to operate at a significant loss over the next 12 months”, despite expectations of improving ridership.

Reiterate Fully Valued, TP cut to S$1.88. We believe that the counter is overvalued. While the long-term prospect for rail in Singapore is positive, we believe the market has overlooked near term humps, with SMRT trading at peak PE of c.21x. Our TP is adjusted down to S$1.88 on lower earnings, based on the average valuation using 15x PE ( FY11F) and DCF. We reiterate our Fully Valued recommendation.

Circle Line ridership below expectations

• Below; maintain NEUTRAL. 1Q11 net profit slipped 20.7% yoy to S$38.2m, 13% below our forecast (22% of our FY11 estimate) and consensus estimate due to higher-than-expected operating expenses. To incorporate this, we have cut our FY11-13 earnings estimates by 7-12%. Our DCF-derived target price accordingly dips from S$2.35 to S$2.31 (WACC 9%, terminal growth 2%). Maintain NEUTRAL as we believe SMRT’s earnings will continue to be hurt by a 2.5% fare reduction and higher operating expenses. In line with expectations, no dividend was declared. We see re-rating catalysts from higher-than-expected Circle Line ridership and lower-than-expected electricity costs.

• EBIT fell 20.3% yoy. Revenue grew 9.0% yoy, with contributions from the Circle Line Stages 1 & 2, higher rental revenue and higher bus ridership, partially offset by lower revenue from Palm Jumeirah. Staff costs rose 9.8% yoy. Electricity and diesel expenses rose 28.8% yoy on costlier energy while repairs and maintenance went up 8.9% due to more scheduled repairs and maintenance for trains and taxis.

• Challenging outlook. We expect fare-based revenue to be affected by the 2.5% fare reduction effective Jul 10. Since the opening of Stages 1 & 2, Circle Line’s average daily ridership has risen from 124k to almost 145k. Still, this is below the 200k expectation. According to SMRT, the lower-than-expected ridership and rise in electricity costs will continue to affect the Line’s profitability. While SMRT expects Circle Line’s ridership to improve, it believes the Line will continue to operate at a significant loss over the next one year. Furthermore, staff and electricity costs are expected to be higher yoy. However, SMRT expects rental revenue to be higher yoy thanks to additional rental space.

1QFY11 bottomline disappoints

Below expectations. SMRT Corporation reported 1QFY11 revenue of S$235.3m (+9.0% YoY, +4.6% QoQ), driven mainly by higher MRT and bus ridership, contribution from Circle Line (CCL) Stages 1 and 2, and higher rental revenue. This is largely within our expectation of S$233.4m revenue for the quarter. However, other operating income (OOI) fell by a steeper-than expected 66.8% YoY (-48.6% QoQ) due to lower other maintenance and related income. Hence, while we have adequately factored in an increase in operating costs, as guided by management in its 4QFY10 results, PATMI of S$38.2m (-20.7% YoY, +68.8% QoQ) missed our earnings expectation of S$41.8m. The quarterly topline and bottomline formed 24.4% and 22.9% of our FY11F sales and PATMI forecasts respectively (24.0% and 21.5% of consensus).

Management warns of lower profitability in FY11. SMRT revealed that the average daily ridership from CCL since the opening of Stages 1 and 2 had risen to 124-145k, as compared to ~40k from Stage 3 alone. This is consistent with our projection of 135k, but lower than LTA’s expected ridership of 200k. Management warns that this shortfall in ridership, coupled with rising electricity costs, is likely to result in CCL operating at significant loss over the next 12 months. In addition, staff and related costs are expected to add further burden to its operations, due mainly to the absence of jobs credits (S$1.2m in reported quarter vs. S$4.4m in 1QFY10), increased headcount and higher CPF rates. The group also guided that OOI should normalize to ~S$20m for FY11 due to absence of one-off items in FY10 (which helped to lift its FY10 contribution to S$43.2m). Thus, while rental revenue is expected to be higher in FY11 with increased lettable retail space, management cautions that its profitability in FY11 may not be maintained.

Downgrade to HOLD. In light of the results and challenging outlook, we now ease our FY11F earnings by 8.2%. We also tweak our dividend assumptions and parameters of our DDM model to match our earnings revision and to reflect the stock’s higher systematic risk (cost of equity: 6.4%, terminal growth rate: 2% currently). This eases our fair value to S$2.16 from S$2.33 previously. While we are positive on SMRT’s growth story in the public transport sector space in the longer term, we believe the drag in its profitability is likely to limit its upside potential in share price in near term. At current level, we downgrade SMRT to HOLD on valuation grounds.