Forecasts cut, fair value reduced

• SMRT Corp Ltd results came in sharply below ours and market expectations, at 10% below consensus EPS of 11.9 cents Singapore.

• We have cut EPS by 3%-4% to 10.3 cents for FY11F and 10.9 cents for FY12F. The lowered operating performance also reduces our fair value by 9% to S$1.99. Stock now trades at premium of less than 15% and we maintain our HOLD rating.

• Only bring spot is a hike in DPS to 8.5 cents for FY10 (7.75 cents in FY09), with final 6.75 cents declared. We believe this would be possible to maintain going forward; however, on recent price surge, yield of 4% p.a. is not compelling.

• SMRT’s 4QFY10 expense growth of 10% YoY, brought operating profit plunge of 28% to S$27mil. This muted FY10’s operating profit growth to 5% YoY. Lower interest and investment income and higher tax rate at 15%, led to flat net earnings of S$163mil.

• Nasty cost surprises were particularly in the area of staff, and repair and maintenance. This hit operating profit margins hard for train and bus operations. Margins in 4QFY10 for train fell to 64% while bus fell to -11%, versus 70% and 3% respectively for 4QFY09. Going forward, firm oil prices caps potential for upside surprises.

• Ramped up requirements for line CCL 1 and 2 since April 2010 opening, and preparation for CCL 4 and 5 (13 stations) opening in FY12, will ensure no let up in such cost increases. At the same time, savings from Jobs Credit will cease from July 2010.

• SMRT’s fare business performed in line with expectations at topline – FY10 ridership grew 5% YoY to 536.6 million for train and +0.7% YoY to 290 million for bus – though faring worse than FY09 due to a weak 1HFY10. One encouraging note was a pick up in momentum for 4QFY10, with 10% YoY for train and 3% YoY for bus.

• We maintain our FY11 ridership forecast at 9% YoY for train and 6% YoY for bus; buoyed by a strong economy as well as enhanced attractiveness of public transportation with progressive stages of CCL. The Land Transport Authority projects 200,000 ridership for operational CCL 1, 2 and 3.

• Fare cuts implemented on 1 April 2009 resulted in 4% YoY fall in average train fares and 6% YoY fall in average bus fares for FY10. The new fare structure from July 2010 will be mildly positive, offsetting much of the end to a 3% temporary cut for April 2009 to June 2010.

• One bright spot in non-fare business is that management expects incremental revenue of S$6mil in FY11 from new commercial space to be added at nine stations – of which Orchard and Esplanade Xchange will account for a combined 3,600 sq m.

• Management plans to add to its current taxi fleet of 2,572 as well; however on rising COE prices, yield would be less attractive. Capex projections is now raised to S$150-S$200mil for FY11.

Positives priced in

• Below; downgrade to NEUTRAL. FY3/10 net profit slipped 0.1% yoy to S$162.92m, 9.7% below our and consensus estimates. The underperformance was due to higher-than-expected operating expenses, mainly a result of higher-thanexpected repair and maintenance costs for its bus operations. It also announced a final dividend of 6.75 cents/share. We cut our FY11-12 earnings estimates by 7-8% to account for lower revenue, no thanks to lower average fares from July 2010 onwards and higher operating expenses. We also introduce our FY13 earnings estimates. Due to our earnings cut, our DCF-derived target price is reduced from S$2.41 (WACC 9%, terminal growth 2%) to S$2.35. We downgrade SMRT from Outperform to NEUTRAL as we believe that positives from the opening of Circle Line stages 1 & 2 have been priced in. The stock price has done well in Apr (+11%) and its dividend yields of 3-4% are no longer attractive relative to the S-REITs.

• EBIT rose 4.5% yoy. Despite fare reductions, revenue grew 1.8% yoy, thanks to contributions from the new Circle Line, higher rental revenue and higher overseas revenue. Staff costs rose 6.3% yoy while energy costs fell 12.3% yoy due mainly to lower diesel prices. Repair and maintenance costs rose by 19.4% yoy.

• Operational review. FY10 train revenue rose 1.4% yoy, thanks to higher average ridership (up 5.2% yoy) and contributions from Circle Line’s stage 3 (the first stage to open), offset by lower average fare for MRT. However, bus revenue fell 3.6% yoy on lower average fare. Taxi revenue was down 1% yoy due to a smaller average holding fleet. Rental revenue grew 13% yoy, driven by improved yields and increased rental space. As at Mar 2010, the total lettable space was 28,909 sq m. In FY11, SMRT will have more rental space coming from nine more stations (including six new ones).

• Operating expenses to be higher in 1Q11. SMRT expects 1Q11 revenue to be higher yoy due to the newly-opened Circle Line stages 1 & 2 and higher MRT and bus ridership. However, SMRT also guided for higher opex yoy due to higher energy costs and higher staff costs related to the Circle Line.

Disappointing Q to end the year

• Revenue for FY10 was 3.6% higher at S$938m, net profit up 0.1% to S$162.8m

• Results were disappointing, much lower than consensus estimates

• Declared final dividends of 6.75 cents, bringing FY10 total to 8.5 cents

• Downgrade our price target to S$2.36 to reflect higher operating costs for 2011

• Maintain Hold rating as potential upside is limited to 3.5% to our fair value

Results were disappointing

4Q10 revenues were up 3.7% y-y to S$225.1m, while net profit was down 41.4% y-y to S$22.7m. For FY2010 revenues came in at S$938.2m (+3.6% y-y), which was slightly ahead of our expectations of S$932 due mainly to higher riderships, higher rental revenues and fees from overseas projects. Operating expenses has taken its toll on SMRT as total operating expenses increase 10.1% y-y to S$206.6m due mainly to higher staff costs, higher maintenance and repair costs. This came as a surprise as FY2010 was supposed to result in lower operating costs due to the global recession. As a result, net profit edge up marginally to S$162.8m (+0.1% y-y).

Bright spot for FY2010

SMRT announced a final dividend of 6.75 cents bringing the total dividends for FY2010 to 8.5 cents, this is much higher than the 7.75 cents for FY2009. The dividend increase was on the back of flat earnings growth which means payout was much higher for 2010 and we are hopeful that the management will maintain the higher payout for FY2011.

Outlook and estimates for FY2011

We are forecasting revenues to increase by 7%to S$1.0 billion to reflect the higher earnings from higher ridership numbers, higher rental and advertisement. Train riderships are expected to grow as circle line stage 1 & 2 starts to contribute with LTA forecasting daily riderships to reach 200,000 eventually and average fares will likely edged up. We are expecting rental and advertising segment to grow strongly in 2011; the opening of Esplanade Exchange and various circle line stages coupled with the better economic outlook will generate more space and higher rates. Advertising will likely benefit from the upcoming Youth Olympics, World Cup and the opening of 2 integrated resorts. However the management guided that operating costs will be likely be higher with the increased headcount, higher electricity prices and cessation of the budget assistance package.

Valuation and Recommendation

We are maintaining our Hold recommendation but downgrading our fair value estimate to S$2.36 to reflect the higher operating costs environment for 2011. SMRT could be impacted by higher electricity prices, labour costs and higher repair costs, as its fleet of buses and trains gets older. SMRT is currently trading at 21.3X FY10 earnings, which is 22% higher than its historical average of 16.6X and close to its all time high of 22.2X, maintain Hold. 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$2.36 from S$2.42 representing a potential upside of 3.5% from the closing price.