Still riding against headwinds

• 2Q13 net profit within expectations with marginal 2% drop; 1H13 accounts for 50% of our FY13F
  
• EBIT margins dropped 1.7ppts on higher operating costs
  
• Cut in interim DPS of 1.5 Scts was expected, down from 1.75 Scts in 1H12, due to higher capex
  
• Above mean valuations unwarranted, dividend yield at 3.9% is unattractive, maintain Fully Valued. TP at S$1.50
  

Highlights

2Q13 within expectations. 2Q net profit dipped 2% y-o-y to S$33.3m despite an 8% increase in revenue to S$281.2m. 1H13 accounts for 50% of our FY13F forecasts. All business segments registered revenue growth, except Engineering due to lower consultancy revenue. Rail continued to be the main revenue driver with average daily ridership up by 7.3% to 1.9m. This was helped by Circle MRT Line (CCL) average ridership of 350k/day.

Margins under pressure from higher costs. EBIT margins dipped by 1.7ppts to 14.4% as a result of higher staff costs (+10% y-o-y), depreciation (+20%), repairs and maintenance (+28%) and other operating expenses (+10%). This was partially mitigated by lower electricity and diesel costs (-6%) due to lower tariffs and diesel price.

Our View

Lower interim DPS of 1.5 Scts not a surprise. The Board declared a lower interim DPS of 1.5 Scts (1H12: 1.75 Scts), which was not a surprise to us given the higher capex needs and operating expenses. Management had guided for capex of S$500m in FY13F, and S$118.5m has been incurred as of 1H. As such, we should see a significant ramp up in capex in 2H.

Lacklustre growth. While ridership is expected to grow, operating costs is projected to increase at a faster pace due to higher staff costs, repair & maintenance and depreciation. Thus, bottomline growth is expected to remain unexciting.

Recommendation

Maintain FV, TP unchanged at S$1.50. The stock is trading at c.0.5 std dev above its historical trading mean (c.16x), which is unwarranted in our view given its lackluster growth due to higher operating costs. Maintain FULLY VALUED recommendation with an unchanged TP of S$1.50. Furthermore, lower interim dividends should further signal the Board’s conservatism in its payout in view of capex and operational challenges, thus undermining its attractiveness as a yield counter.

Interim Dividend Cut on Cautious Outlook

1HFY3/13 results, dividend cut in line with our forecasts. SMRT reported 1HFY3/13 NPAT of SGD69.8m, which came in at 50% of ours and consensus’ full-year estimates. In our July 2012 land transport sector note “No light at the end of SMRT’s tunnel yet”, we had cut our FY3/13 dividend forecast by 10% due to impinged cashflow. This projection was seemingly validated as SMRT cut its interim dividend by 14% from SG1.75cts/sh to SG1.50cts/sh on the premise of prudence – management guided that FY3/13 will remain challenging on cost pressures and lack of fare adjustments until 2013. We maintain our SELL call, and roll forward our valuations based on FY3/14 PER.

Buses still weighing down transport portfolio. SMRT’s bus business continued its poor results, as operating profits were down SGD4mil (-157% YoY) on increased staff costs from salary revisions and higher depreciation and R&M costs associated with a larger fleet. This was mitigated by operating profit growth YoY in the rail (+6.5%), taxi (+SGD1.2m) and commercial space rental (+7.4%) segments.

Government help still not guaranteed. Management shared that the company had applied to, and was awaiting a response from the LTA for asset replacement grants for funding part of the SGD900m asset renewal plan announced earlier. In addition, grant amounts / formulas have yet to be nailed down for the sharing of bus shelter advertising revenues as part of the Bus Services Enhancement Programme (BSEP).

Outlook challenging, yields unattractive – reiterate SELL. The future for SMRT looks daunting as operating costs escalate, the group takes on debt (now net debt vs net cash in FY3/12), and fare revisions likely only kick in from mid-2013. We roll forward our valuations to 15x FY3/14 PER, maintaining our SELL call and adjusting our Target Price accordingly to SGD1.37. SMRT’s stable-to-increasing dividends are a thing of the past, as our forecasts of a full-year dividend cut to SG 6.8 cts/sh (~74% payout ratio) are also maintained.

Profits flattered by one-off gains

Company Overview

SMRT is a multi-modal land transport operator with exposures to various modes of operations, including rail, bus & taxi services. A significant part of its profits are generated from its ancillary businesses, such as advertising & rental of commercial spaces.

• Revenue growth in line with expectations

• Profits flattered by net one-off gain of S$4.5mn

• Undeserving of premium valuations with ongoing challenges to the business

• Maintain Sell with target price of S$1.35

What is the news?

Revenue for SMRT continued to trend north, driven mainly by higher ridership on its rail network with the full opening of Circle Line. Despite significantly higher operating expenses, the Group's EBITDA margins improved by 61bp in the quarter. Consequently, profits for SMRT increased by 4.7%y-y. Management highlighted that operational challenges for the Group remain, as profitability is expected to be impacted by higher staff, depreciation and repair & maintenance costs.

How do we view this?

The strong 4.7% increase in net income was flattered by one-off items that were booked in the quarter. After adjusting for the one-off net gains of S$4.5mn booked, we estimate that underlying profits would have declined by 8% in the quarter.

Investment Actions?

With our expectations of higher operating expenses and stagnant average fares for the year, we believe that the difficult financial performance for SMRT would persist. Despite the ongoing challenges to its outlook, the stock continues to trade at an undeserving premium valuation of 18X P/E. We roll forward our valuation basis and maintain our Sell recommendation on SMRT with target price of S$1.35.

Profits flattered by one-off gains

Company Overview

SMRT is a multi-modal land transport operator with exposures to various modes of operations, including rail, bus & taxi services. A significant part of its profits are generated from its ancillary businesses, such as advertising & rental of commercial spaces.

• Revenue growth in line with expectations

• Profits flattered by net one-off gain of S$4.5mn

• Undeserving of premium valuations with ongoing challenges to the business

• Maintain Sell with target price of S$1.35

What is the news?

Revenue for SMRT continued to trend north, driven mainly by higher ridership on its rail network with the full opening of Circle Line. Despite significantly higher operating expenses, the Group's EBITDA margins improved by 61bp in the quarter. Consequently, profits for SMRT increased by 4.7%y-y. Management highlighted that operational challenges for the Group remain, as profitability is expected to be impacted by higher staff, depreciation and repair & maintenance costs.

How do we view this?

The strong 4.7% increase in net income was flattered by one-off items that were booked in the quarter. After adjusting for the one-off net gains of S$4.5mn booked, we estimate that underlying profits would have declined by 8% in the quarter.

Investment Actions?

With our expectations of higher operating expenses and stagnant average fares for the year, we believe that the difficult financial performance for SMRT would persist. Despite the ongoing challenges to its outlook, the stock continues to trade at an undeserving premium valuation of 18X P/E. We roll forward our valuation basis and maintain our Sell recommendation on SMRT with target price of S$1.35.

One-off fine is no surprise

The LTA will impose a S$2m fine on SMRT for December’s service disruptions. This fine has been widely expected and should not result in knee-jerk selling. We are not too bothered by this one-off cost. Rather, we worry about a structural increase in SMRT’s opex.

We are keeping our EPS forecasts intact as the quantum of the penalty is within expectations. Maintain Underperform and our DCF target price (WACC: 6.6%). We anticipate de-rating catalysts from falling dividends and margin compression.

What Happened

LTA has fined SMRT the maximum penalty of S$2m for two instances of service disruptions on the North-South Line in December 2011. The fine translates to 1.4% of our FY13 profit forecast. We believe that SMRT will have no issues funding this via its operating cash flows. In reaching this decision, LTA highlighted lapses in SMRT’s due diligence and maintenance, among other shortcomings. Funds will be donated to the Public Transport Fund to provide needy families with financial assistance.

What We Think

This fine has been widely anticipated and should not result in knee-jerk selling. We view this fine as a one-off expense that should not eclipse the permanent elevation in SMRT’s cost structure arising from higher repairs and maintenance costs. We forecast a 0.3%-pt decline in recurring net profit margin in FY13, dampened by higher maintenance and energy costs. We expect positives from falling energy prices to be eroded by higher energy consumption and staff costs as the group increases the frequency of train and bus runs to meet Singapore’s growing ridership.

What You Should Do

We maintain our preference for ComfortDelGro over SMRT for exposure to Singapore’s land transport sector. SMRT’s efforts to improve service reliability will result in higher staff costs as the group beefs up its technical team, as well as maintenance costs in a bid to implement a more pre-emptive maintenance regime. We expect lower dividends in FY13 as free cash flow weakens on higher capex spending.