Still Worth Paying For

Still worth paying for. SMRT Corporation (SMRT) has, over the last 18 months, been trading at about 23.5% over and above the sector average, based on the PE metric. Even on a P/B basis, the stock is not cheap, trading at 3.6x P/B (though this is largely due to its low fixed asset base). However, the stock is still worth paying for, given its strong margins that outshine that of sector peers, outstanding return on assets (ROA), sustainable dividend payouts based on solid earnings, and its ability to leverage on the Singapore growth narrative.

Growth potential not yet exhausted. We view SMRT as a play on Singapore’s growth trajectory, and the rail system as the biggest beneficiary of the government’s push to nudge commuters and peak hour traffic towards public transport. The rail system is, by far, the best alternative transport method to avoid congestion on roads.

Stronger operating performance than peers’. We compare SMRT and sector comparables and find that the company commands the highest margins and ROAs among listed land transport operators. SMRT also has the added silver spoon advantage of lower capex due to strong government support.

Maintain BUY; target price raised to S$2.00. We have lowered our profit forecasts (by between -5.1% and -6.3%) and changed our valuation methodology from PE to discounted cash flow. We value SMRT using the firm’s discounted free cash flow to equity at S$2.00/share (6.9% COE, 1% terminal growth). Our revised target price (up from S$1.86) gives a return of 17% over the last closing price of S$1.71.

Circle Line operating performance may see upside

• Circle Line ridership could surprise on the upside: The Circle Line (CCL) attracted a daily ridership of about 30,000 – 35,000 during its first week of operations since the 5-station, phase 3 of the 29-station lines opened in May 2009. This is better than our estimate of 25,000. The remaining phases will be opened from 2010. With the CCL being a “transfer line” cutting across the other lines, it should be able to capture a good amount of ridership share.

• Might be net beneficiary of centralized bus planning: SMRT’s bus network currently spans the less densely populated areas of Singapore. The LTA is in the process of re-planning the whole bus network under its centralized bus planning exercise. SMRT could emerge a net beneficiary from this exercise, as routes get redistributed so that it could have a chance of securing the more lucrative bus services.

• Retail space rental earnings could see slower growth: Retail space rental experienced phenomenal growth in the past on the back of aggressive refurbishment of existing stations and the conversion of bigger underground stations into “Xchanges” housing more retail shops. Going forward, we believe that the growth from this segment could plateau as the CCL is fully underground and the stations are smaller, translating to less lettable retail space. This segment currently contributes about 23% of SMRT’s operating profits and is the second largest profit contributor after the core MRT business.

• Valuation, risks: At 15.4x FY10E P/E, we believe the stock is fairly valued, trading above its historical mean forward P/E of 13.5x. Upside risks could come from the CCL breaking even faster than the FY 2013E in our assumption.

Investment Highlights

• We initiate coverage of SMRT Corp Ltd (SMRT) with a BUY rating. Fair Value of S$2.11 presents a 19% upside to current price. We have applied a DCF approach to SMRT’s
  steady cash flows, with terminal growth at 1% and netting off S$1bil for the 30-year licence extension and transfer of assets for the new Circle Line.
• Amid a slow economy, SMRT’s earnings are defensive with 80% revenue derived from the public transport fare business. We expect ridership growth on trains and buses to be supported, as costs of private vehicle usage continues to increase, while its rail and bus network continues to improve in terms of convenience (connectivity, shorter travel times and shorter headways) and affordability.
• We project 12% growth in mass rapid transport (MRT) ridership for SMRT to 572mil in FY10 and 9% to 623mil in FY11. This will offset average fare cut of 4.6% implemented from 1 April 2009 until end-June 2010.
• With the progressive opening of SMRT’s new Circle Line – first phase having started in May 2009 with 2nd phase in 2010 and 3rd phase in 2011 – we would expect some new
  comers to public transport. But the impact will be somewhat muted on incremental ridership as some rides on Circle Line may cannibalise rides from SMRT’s other two
  MRT lines. Early estimates put ridership on Circle Line’s first phase at 55,000 per day, rising to 0.5 million at a steady state upon full operations of the entire line.
• Lacklustre taxi operations will be offset by growth in rental and engineering/other services segments. SMRT will continue to redevelop its MRT stations into lettable commercial space, which are in high demand for its location in high pedestrian traffic areas. So far, SMRT has renovated about half of its stations.
• With oil prices off last year’s peak, SMRT stands to benefit as about 20% of its costs are energy-related items. As such we expect an improvement in EBITDA margins from 33% in FY09 to 34% in FY10. But we expect margins to revert to 33% in FY11 with increasing costs from further phases of the fully underground Circle Line.
• Steady cash flows can comfortably support capex of S$150mil per annum for continual upgrading and expansion of transport fleet, station renovations and other system and service improvements. This leaves enough room to maintain DPS at 7.75 cents Singapore per annum. In addition, we estimate a potential for paying out a special dividend of 1.5 cents in FY11 if management wishes to.