Author: kktan
ComfortDelgro – OCBC
Key beneficiary of policy change
- Local bus operations a drag
- Good position to win tenders
- Preferred pick within sector
Core Singapore bus operations loss making since FY11
ComfortDelGro’s (CDG) core Singapore bus operations (operated via its 75%-owned subsidiary SBS Transit) has been a drag to its financial performance, raking in losses ranging from S$6-15m per year since FY11. During its recent 1Q14 results, CDG once again reported an operational loss of S$4.7m for its local bus business (excluding advertising and rental income), although this was an improvement from the S$5.4m loss suffered in 1Q13. The main issue is the lack of a commensurate increase in fare adjustments (last increase came in 2011 prior to the recent 3.2% increase implemented on 6 Apr 2014) despite heightened operating requirements from a growing population.
Brighter days ahead
Following LTA’s decision to implement a “Government gross cost contracting model”, we expect more significant improvements in its bus operations ahead, although the financial impact will only be felt in 2H16. As one of the Government’s objectives is to inject more competition into the industry, CDG comes under risk of losing its market share (~75%) since ~20% of existing buses will be put up for competitive tender in 2H14 (implementation will only take place in 2H16). Nevertheless, we believe CDG’s strong knowledge of the local operating environment and experience in operating a gross cost contracting model for its UK and Australia bus businesses will put it in a good stead to clinch the upcoming tenders.
Maintain BUY
CDG generated an operating margin of 8.4% and 19.2% for its UK and Australia bus businesses in FY13, respectively. LTA said that it has studied the London and Australian bus contracting models over the past two years, and hence we believe CDG will use these two countries as a benchmark, especially its UK operations, when it submits its tenders. Despite keeping our FY14-15 forecasts intact, we raise our FY16-18 PATMI projections by 4-12%, based on an 8% operating margin assumption for its Singapore bus operations. Consequently, our DDM-derived fair value is raised from S$2.30 to S$2.56. Maintain BUY. CDG remains as our preferred pick within the land transport sector.
Land Transport – OCBC
Another step towards sustainability
- “Government contracting model”
- Turnaround in operations expected
- CDG likely to benefit more than SMRT
Restructuring Singapore’s public bus industry
LTA announced that it will restructure the public bus industry to a “Government contracting model” beginning from 2H14 (but implementation to take place only in 2H16 after the expiration of the current Bus Service Operating Licenses on 31 Aug 2016). This is aimed at improving service quality and injecting more competition into the industry. The key implication of this is that revenue risk will now fall under the Government instead of the public transport operators (PTOs). Under this model, bus operators will bid for the right to operate bus services via a competitive tendering process. The Government will own all bus infrastructure and operating assets. We believe this means LTA may buy over existing bus assets from the PTOs in the future, although the timeline is unclear. The net book value of SBS Transit’s (75%-owned by ComfortDelGro) buses is S$817.5m (as at 31 Dec 2013), while that of SMRT is ~S$200m (as at 31 Mar 2014), based on our estimate. Three out of 12 bus packages (~20% of existing buses) will be tendered out starting from 2H14, and the contract length will be five years (can be extended by another two years on good performance). The remaining 80% of buses will continue to be operated by the incumbent operators, and these will also come under the new contracting model when their licenses expire on 31 Aug 2016 (five year tenure).
CDG to benefit more than SMRT
Overall, we believe this will enable the PTOs’ bus operations to return to profitability. During their most recent full-year results, ComfortDelgro (CDG) and SMRT reported operating losses of S$14.4m and S$28.4m, respectively, for their core Singapore bus operations (excluding advertising and rental income). We expect CDG to be a bigger beneficiary than SMRT as the former operates the largest bus fleet in Singapore (~75% market share via SBS) and also has experience operating a gross cost contracting model for its UK and Australia bus businesses. It generated an operating profit margin of 8.4% and 19.2% for these two areas in FY13, respectively. We believe a 6-9% operating margin can be achieved by the PTOs.
Upgrade sector to OVERWEIGHT
The Singapore Government’s initiative to move towards a gross cost contracting model is a positive paradigm shift which we believe will help to ensure the longer-term sustainability of Singapore’s public bus operations. Although the financial impact will only take place in 2H16, we believe efforts to improve productivity (PTOs’ bus losses have narrowed) and changes to the fare adjustment system will aid the sector’s recovery in CY14 and CY15. Hence we upgrade the land transport sector from Neutral to OVERWEIGHT. We maintain our BUY rating on CDG (FV lifted from S$2.30 to S$2.56) and HOLD rating on SMRT (FV lifted from S$1.25 to S$1.40).
SATS – Maybank Kim Eng
Await better entry point
- 4QFY3/14 net income of SGD42.6m (-7.8% YoY) fell short of market expectations due to elevated labour costs.
- The other disappointment: Lower-than-expected full-year DPS of 13 SGD cts (FY3/13: 15 SGD cts).
- Downgrade to HOLD with lower TP of SGD3.30 in view of near-term challenges that could cap share price upside.
What’s New
SATS reported 4QFY3/14 net income of SGD42.6m (-7.8% YoY), which was below market expectations. Labour costs remained the key pressure point in 4QFY3/14, rising 5.3% YoY due to tight labour market in Singapore and Hong Kong. Full-year DPS was lowered to 13 SGD cts from 15 SGD cts (of which 4 SGD cts was special) translating to an 81% payout. Despite growth in workload, operating profit for the Gateway Services segment weakened to SGD13.8m in FY3/14 (-34%), while Food Solutions segment declined by a smaller quantum of 11% to SGD141.9m. The outlook appears mildly negative with management blaming it on rising costs and the overcapacity issue in the regional aviation market.
What’s Our View
While SATS remains a good exposure to the Changi Airport expansion story, we believe near-term earnings will remain weak as it struggles to contain escalating costs. While initiatives to reduce labour dependency are positive, they are unlikely to result in any material near-term benefits. The persistently weak air freight market will continue to weigh on its operations in Singapore and associates that are highly geared to the cargo business. Hence, we lower our FY3/15-16E EPS forecasts by 8%/7% and see significant downside risk to consensus estimates. Accordingly, we trim our DCF-based TP to SGD3.30 (WACC = 7.6%, tg= 1.0%) from SGD3.47 previously and downgrade our rating to HOLD. However, we see limited share price downside at 4% dividend yield, which is supported by its net cash position.
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.
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.