Imminent Changes To Bus Operating Model

Current bus model is not sustainable; Tender system a possibility. With stagnating bus fares and rising cost from inflationary pressure, the two existing operators have been running loss-making operations for years. Under a business model that is financially unviable, we believe that SMRT and SBS Transit, a subsidiary of ComfortDelGro, would be reluctant to renew their bus licences when they are due in 2016. Hence, a change to the bus model is imminent, in our view, in favour of a tender system to award packages of service contracts. We believe that the Land Transport Authority (LTA) is currently evaluating the merits of a tender system, as evident from the tender system used to award service contracts since the start of the year.

Tendering system would likely reverse losses – upside to profits. In the near term, switching to a tender system will be positive for the Public Transport Operators (PTO), as losses at their bus units will reverse. The future profitability of the bus business would depend on the bids placed during tenders. Our analysis suggests that our profit estimates for next year would be raised by 18-22%, if the PTOs retain their current market share and their bus units achieve a 10% margin under the new business model

Key negatives for PTOs under new system. It appears that under a tendering system, the PTOs will be able to reverse losses and turn profitable. So what is the catch? We caution that there are at least three areas that would be negative for the two existing operators under a tender system: heightened competition, higher cost to ensure better service standards and shorter service contracts.

Net effect should still be positive for existing PTOs. While competition from new entrants would pose a threat, we believe that existing operators would still have an edge over new entrants with their scale of operations. Even if the existing operators do concede market share, their profitability under a tender system would still be an improvement over their current loss-making operations.

Sticking with current calls: BUY CDG, SELL SMRT. While switching to a tender system is positive for both PTOs, we maintain our preference for CDG over SMRT. We believe that our forecasts for significantly higher gearing at SMRT over the next few years will be reflected in lower stock valuations. Furthermore, PER valuations for CDG are relatively more attractive under various bus margin scenarios on a tender system. Reiterate BUY CDG, SELL SMRT.

Slower ridership growth for operators

Slower ridership growth a dampener for operators. From Jan – Oct 12, train ridership is up 8.5% versus previous period’s 9.8% and bus ridership is up 3.8% from Jan – Oct 12 versus previous period’s 6.1%. We believe slower ridership growth is partially attributable to slower population growth (Singapore’s population growth has slowed to 2.5% in mid 2012 versus its prior 5-year CAGR of 3.3%). We also think population growth could remain soft given the government’s stance on managing foreigner inflow and moderating Singapore’s GDP growth expectations. As operators continue to face cost pressures, we maintain our NEUTRAL call on the sector, with preference for ComfortDelGro (CD) (S$1.72 BUY TP S$1.85) for its cheaper valuations and overseas growth potential over SMRT (S$1.69 NEUTRAL TP S$1.60).

Jan – Oct 12 ridership for rail and bus growing, albeit at a more moderate pace. Ridership for rail and bus continues to grow, due to population growth, as well as high car purchasing costs. However we believe growth is moderating. From Jan – Oct 12, train ridership is up 8.5% versus previous period’s 9.8% and bus ridership is up 3.8% from Jan – Oct 12 versus previous period’s 6.1%. The slower pace in ridership growth coupled with an environment of higher repair and maintenance and staff costs will likely weigh on operators’ margins.

Population growth slowing down. Singapore’s population growth has slowed to 2.5% in mid 2012 versus its prior 5-year CAGR of 3.3%. The Ministry of Transport (MOT) has capped Singapore’s annual vehicle growth rate at 0.5% pa from Feb 13 to Jan 15, and COE (Cat A) prices has spiked 50% YoY to S$78,523 in Dec 12. While we expect more commuters to switch to rail and bus transportation due to the higher car ownership cost, this may not be able to compensate against expected softer population growth given the government’s stance on managing foreigner inflow and moderating Singapore’s GDP growth expectations. We think catalysts for the operators could come from a fare revision formula expected in 1H13.

ComfortDelGro remains our preferred pick due to cheaper valuations and overseas potential. We remain NEUTRAL on Singapore’s land transport sector due to slower ridership outlook stemming from slower population growth as well as cost pressures that could cling in the near term. We favour CD over SMRT due to the former’s cheaper valuation and greater overseas exposure. CD’s overseas operations accounts for 46% of its EBIT. CD’s average overseas EBIT margin of 12.7% is also higher than the 10.4% for its Singapore operations. CD is currently trading at a more attractive 14.5x FY13 P/E vs SMRT’s 19.0x FY13 P/E (FYE Mar).

New Taxi availability standards

We expect minimal impact to operators. LTA has announced new taxi availability standards to be implemented from 1 Jan 13. This will involve having taxi availability during peak periods (For 2013: 65% of taxis on the road from 6am-7am, 11pm-12am, and 70% from 7am-11am, 5pm-11pm), as well as general availability throughout the day (70% of taxis with minimum daily mileage of 250km). Any financial penalty implemented could begin from Jun 13 onwards. We believe the impact on operators will be minimal: (1) ComfortDelGro (CD) has high chance to have already met criteria with currently 80% of its fleet running on two shifts with average daily taxi mileage of 400km, while (2) SMRT’s fleet, of which less than 50% is running on two shifts could benefit from LTA’s measures to complement taxi availability. Maintain BUY on CD with TP of S$1.85 and NEUTRAL on SMRT with TP of S$1.60. We prefer CD on the back of overseas expansion potential and cheaper valuations with CD trading at 13x FY13 P/E compared SMRT trading at 19x FY13 (FYE Mar) P/E.

CD likely to have already met new Taxi availability standards. CD currently has 80% of its fleet running on two shifts compared to 50% for Singapore’s overall taxi fleet. During peak hour periods, it is likely that percentage of its taxis on the road averages above 90% (compared to the 65-70% LTA requirement for 2013). With a high percentage of its fleet running on two shifts (implying likely longer hours on the road), its average daily mileage per taxi currently stands at 400km (versus the required 70% of taxis with min. daily mileage of 250km for 2013). As such, we believe CD would likely meet the standards set by LTA.

SMRT has room to benefit from LTA’s complementary measures. SMRT has less than 50% of its fleet running on two shifts (below Singapore’s overall 50% level). While this could imply a chance that SMRT is not meeting the minimum requirements set by LTA, we believe LTA’s measures to complement taxi availability such as (1) relaxation of CBD taxi pick up/drop off points, (2) online portal to aid matching between taxi hirers and relief drivers, and (3) discounts on Taxi Driver’s Vocational Licence renewal fee for “active” drivers, will help improve average daily mileage as well as more conversions towards double shifts.