Forging ahead along the bus route

Pair trade opportunity. The heat issuing from the massive MRT disruptions last December has hardly dissipated when commuters are again getting hot under the collar over the sheer deluge of tax dollars being deployed to solve a problem created by operators and who now seem to be benefiting from the government’s intervention. From recent sector events, we believe that ComfortDelgro (Buy, TP $1.85) rather than SMRT (Sell, TP $1.41) will be the overall winner and this presents a unique pair trade opportunity to gain from both a 20% upside to ComfortDelgro (long) and 19% downside to SMRT (short).

Hybrid system the best model. Under Budget 2012, the government will set aside $1.1b under the Bus Services Enhancement Programme (BSEP) to fund a significant expansion of bus capacity in response to rail woes. This is the latest intervention in a long series to improve a public transport system that has proven poor in self-regulation. But even before the latest MRT breakdowns and overcrowding that prompted this move, the government’s hand is already obvious in a number of areas, most notably, control of rail capacity expansion and central planning of bus routes. If indeed the government is needed to continually intervene in private sector matters, why not just take it over wholesale? In our view, the hybrid system is perhaps the best model possible under the circumstances.

ComfortDelgro the clear winner. The BSEP and other initiatives are clearly directed at promoting bus ridership. Putting more buses on the road is a quicker fix compared to adding new rail lines. We believe this move is a boon for ComfortDelgro as the market leader in bus operations. However, an expanded fleet will mean stiff competition for bus captains, and we think that SMRT may get the short end of the stick. There is also the consideration of wage negotiations with labour unions that must be adroitly handled. From a longer-term perspective, one can argue for a consolidation in the public transport market, in which case we think ComfortDelgro would be the preferred operator. But this matter would first require a rethink of the government’s sacred cow policy of having at least two operators in every market.

Buy ComfortDelgro, avoid SMRT. We reiterate our preference for ComfortDelgro over SMRT, and believe that it justifies a higher 16x PER valuation based on recent initiatives to improve bus ridership. Its geographically diverse business also offers greater earnings resiliency and more upside potential versus SMRT’s all-domestic model.

Land Transport

Results commentary. Operating losses of S$5mn for SBST’s bus business, sequential decline in average fares & operating losses at its bus business in China resulted in the lower than expected earnings for CDG. While SMRT’s profits declined significantly in the quarter, the margin pressure felt was inline with our expectations.

Capacity Expansion. Singapore’s Transport Minister updated on plans for the public transport system during the Ministry’s Committee of Supply (COS) debate (See: Transportation Sector Update, dated 8 March 2012). Initiatives to ease congestion and improve service quality for the public transport sector imply that more capacity would be injected into the Bus & Rail network over the next few years. For the Bus network, the government would setup a S$1.1bn Bus Service Enhancement Fund to fund the purchase of 550 buses. The Public Transport Operators (PTOs) would fund another 250 buses, representing total fleet growth of 800 buses (c.20% of current fleet) over the next 5 years. Congestion on the Rail network would also be eased with a 40-70% increase in train fleet across various parts of the network.

No Fare adjustment in 2012. There would be no fare adjustments in 2012. Singapore’s public transport fares are reviewed annually with the maximum allowable fare increase set by a predetermined formula (0.5*ΔCPI+0.5*ΔWI-1.5%). With capacity expansion and rising operating costs, we believe that keeping transport fares unchanged would result in margin compression for the PTOs.

We prefer CDG to SMRT. With Singapore’s fare based business accounting for more than half of the Group’s profits and 77% its sales, SMRT has a significant exposure to the new measures implemented. CDG would be less affected due to the diversity of its global operations. For CDG, exposure to Singapore’s fare based business is much less material at only a fifth of its sales and 3% of profits. When comparing valuations on a Forward P/E basis, CDG’s stock price is much more attractive at 13X as compared to SMRT’s 20X. We maintain our Buy recommendation on CDG and Sell on SMRT.

Public transport should stay a private matter: Tuck Yew

Transport Minister Lui Tuck Yew yesterday defended the country’s model of privately run public transport operators in Parliament. ‘Our current model leaves the operations of trains and buses to commercial entities as we believe the long term public interest is best served this way.

‘The profit incentive drives the operators towards higher efficiency and productivity, which keeps costs as low as possible . . . Otherwise, if the system is inefficiently run, the public will ultimately pay for the higher operating costs, either through higher fares, or greater government subsidies.’

The public transport model has come under scrutiny ever since a $1.1 billion package was announced by the government to supplement the existing privately run bus fleet with 550 buses. The package covers the purchase of the buses and their net operating costs for 10 years.

SBS Transit will get about two-thirds of this allocation, while SMRT Buses will get one-third. The two operators will add 250 buses of their own and the total of 800 buses will represent a 20 per cent increase in capacity.

Some 70 per cent of the additions will be made within the first three years.

Even as Mr Lui cited the privately driven success stories of the MTR in Hong Kong and London Buses, he pointed out the need for the government to ‘take control of key areas’ which include planning rail lines and bus routes, as well as deciding on ‘timely capacity injection to meet ridership growth’.

Transport researcher Lee Der Horng from the National University of Singapore told BT that there was an argument for both the private and nationalised models.

But where Singapore is concerned, the government’s selective intervention now is justified, he said. ‘Based on the government’s efficiency that has been exhibited, we should be able to further increase the government’s involvement in public transport,’ Prof Lee said.

Government involvement has increased somewhat in recent years. The hybrid of asset ownership by the government and operations by a private firm was first introduced for trains on the Downtown Line with SBS Transit as its operator. SBS Transit, which also operates the North East Line (NEL), will add 60 weekly train trips to the NEL from March 19, it was announced yesterday.

This hybrid system might soon spread to buses. ‘We will need to similarly relook the bus financing framework and decide . . . how best to introduce contestability,’ Mr Lui said yesterday.

While the government shells out the $1.1 billion for the additional buses, the operators will be expected to hold up their end of the bargain. Mr Lui said that the operators would be held to service levels for the entire fleet that will go beyond what is required by the Public Transport Council (PTC).

For example, 95 per cent of all feeder services will have to operate within 10-minute scheduled intervals or better during peak periods, up from the current 90 per cent that PTC guidelines dictate.

These requirements, however, will not be enshrined as the PTC’s Quality of Service standards for now.

As a more aggressive way to make operators pull up their socks, the government should consider setting up a separate body to operate the 550 buses, Prof Lee suggested. ‘It will be like a third operator with a different choice and the other two operators will feel the pinch of competition.’

This hike in service standards follows a drop in customer satisfaction about public transport for the second year in a row. The survey for 2011 – carried out in October after fares were adjusted but before the train service disruptions – saw overall satisfaction drop 1.9 percentage points to 90.3 per cent, the Land Transport Authority said yesterday.

On the upside, 69.1 per cent of people believe that public transport had improved from the year before.

This year, some solace will come from the absence of fare adjustments to public transport, according to Mr Lui. Instead, the current fare formula will be reviewed this year but implemented in 2013. PTC member Richard Magnus will head the review committee.

The new fare formula in 2013 could take into account the fact that fare adjustments were not made in 2012, Mr Lui said.