Outlook remains largely positive

• Series of train disruptions
  
• Remains upbeat on same growth catalysts
  
• Lower FV; reiterate BUY
  

A series of unfortunate disruptions

SMRT’s trains experienced five disruptions over the past two weeks across the North-South Line (NSL), East West Line (EWL), Circle Line (CCL), and Bukit Panjang LRT Line. Last year, SMRT were fined S$1.6m for two safety breaches and two train disruptions. Of the S$1.6m, the heavier fines came from the two safety breaches amounting to a total of S$1.3m. On these recent incidents, the longest delay was more than four hours on NSL on 23-Feb due to damaged train components. With these disruptions deemed unacceptable by LTA, we updated in our forecasts to provide for fines in FY16 with an amount slightly more than twice of what was paid in FY15.

Higher expenses expected but growth catalysts still present

SMRT announced last Friday its plans to improve rail reliability. There were two key points that required us to update our forecasts from FY16 onwards: 1) SMRT is expected to expand its workforce of engineers and technicians by another 39% and 24% respectively, by 2018, and 2)SMRT to provide more training to ground staff, setting up maintenance operations centre to support and coordinate response by maintenance teams during rail incidents as well as investing to equip maintenance teams with computer tablets to support maintenance needs. However, we believe its growth catalysts are still valid: 1) energy expenses to see further savings as electricity costs is expected to continue to decrease while FY16 diesel needs are largely exposed, 2) full-year rental income contribution from Kallang Wave Mall in FY16, 3) taxi rental income growth through fleet renewal, 4) core bus operations to turn profitable with forecasted margins of ~9.0%, from 2QFY17 after transit to new bus model, 5) potential LTA’s purchase of SMRT bus assets with lump sum cash payment resulting to possible special dividend and/or acquisitions for growth, 6) longer-term catalyst of transit to new rail financing framework, leading to potential purchase of train assets by LTA, though no timeline is provided by LTA.

Lower FV; reiterate BUY

Consequently, we cut FY16 PATMI forecast by 10.5%, as we incorporate higher expenses and potential fines. We reiterate BUY on SMRT on positive growth outlook although our DDM-derived FV decreases from S$1.90 to S$1.85.

Outlook remains largely positive

• Series of train disruptions
  
• Remains upbeat on same growth catalysts
  
• Lower FV; reiterate BUY
  

A series of unfortunate disruptions

SMRT’s trains experienced five disruptions over the past two weeks across the North-South Line (NSL), East West Line (EWL), Circle Line (CCL), and Bukit Panjang LRT Line. Last year, SMRT were fined S$1.6m for two safety breaches and two train disruptions. Of the S$1.6m, the heavier fines came from the two safety breaches amounting to a total of S$1.3m. On these recent incidents, the longest delay was more than four hours on NSL on 23-Feb due to damaged train components. With these disruptions deemed unacceptable by LTA, we updated in our forecasts to provide for fines in FY16 with an amount slightly more than twice of what was paid in FY15.

Higher expenses expected but growth catalysts still present

SMRT announced last Friday its plans to improve rail reliability. There were two key points that required us to update our forecasts from FY16 onwards: 1) SMRT is expected to expand its workforce of engineers and technicians by another 39% and 24% respectively, by 2018, and 2)SMRT to provide more training to ground staff, setting up maintenance operations centre to support and coordinate response by maintenance teams during rail incidents as well as investing to equip maintenance teams with computer tablets to support maintenance needs. However, we believe its growth catalysts are still valid: 1) energy expenses to see further savings as electricity costs is expected to continue to decrease while FY16 diesel needs are largely exposed, 2) full-year rental income contribution from Kallang Wave Mall in FY16, 3) taxi rental income growth through fleet renewal, 4) core bus operations to turn profitable with forecasted margins of ~9.0%, from 2QFY17 after transit to new bus model, 5) potential LTA’s purchase of SMRT bus assets with lump sum cash payment resulting to possible special dividend and/or acquisitions for growth, 6) longer-term catalyst of transit to new rail financing framework, leading to potential purchase of train assets by LTA, though no timeline is provided by LTA.

Lower FV; reiterate BUY

Consequently, we cut FY16 PATMI forecast by 10.5%, as we incorporate higher expenses and potential fines. We reiterate BUY on SMRT on positive growth outlook although our DDM-derived FV decreases from S$1.90 to S$1.85.

Riding high

• 3Q15 results in line; net profit up by 59% y-o-y
  
• Fare business segments turned in positive EBIT as expected
  
• Sustained low oil price could provide further tailwind for operating results
  
• Maintain BUY, TP: S$1.90
  

Highlights

3Q15 net profit tracking well

• 3Q15 net profit was higher by 59% y-o-y to S$22.6m, driven by revenue growth of 6.8% and lower increase in operating expenses (+4.2%). The higher costs were due to depreciation (+14%), repair and maintenance (+7%) and other operating expenses (+10%), offset by lower electricity and diesel costs (-7.3%). Staff costs increased only marginally by 0.6%. 9M15 net profit accounts for 72% of our forecasts, similar to last year.
  
• The 10.6% q-o-q fall in net income was largely due to a smaller EBIT contribution from taxis (S$0.8m, vs S$3.4m in 2Q15), which we understand to stem from non-recurring write-offs from some early retirements within its fleet. We should see taxis’ contribution revert to normal in 4Q15.
  

Fare business turned in profits vs losses last year

• Fare business turned around with a positive EBIT of S$1.9m, compared to a loss of S$8.9m in 3Q14. The major reversal is a result of significantly lower losses from bus operations at –S$0.5m, vs loss of S$8.7m last year, and is tracking within our expectations.
  
• Non-fare segments continue to perform well with rental remaining as the main EBIT contributor.
  

Outlook

Recently announced fare increase to provide support

• The Public Transport Council (PTC) has just approved a 2.8% fare increase effective 5 April’15, and this should provide support to its bottomline. We have factored this in, and are currently projecting a 22% net profit growth in FYE Mar’16F. We have also pencilled in a 1% fare decline in 2016.
  

Benefits from low oil price to continue

• Oil prices have corrected to below c.US$50/bbl from above US$100/bbl just about six months ago. We expect SMRT to continue to benefit through lower diesel and electricity costs. Assuming oil price continues to stay low at current levels, this should provide further benefit to land transport operators.
  

Bus tender outcome should not pose much downside risks

• The Government Bus Contracting tender for the first package (“Bulim package”) closed on 19 Jan’15, and the results are expected to be out in 2Q15. We have already factored in the incumbents (SMRT/SBSTransit) not winning the competitive tenders and just retaining nine out 12 packages.
  

Valuation

Our target price of S$1.90 is based on the average of our discounted cash flow (DCF) and price-earnings ratio (PER) valuation methodology. We adopt a DCF model as the business has previously shown a stable and predictable pattern, while the PER methodology takes into account near term earnings volatility. We peg our PER valuation at 18x FY16F. DCF methodology is based on a weighted cost of capital at 5.2% and a terminal growth assumption of 1%.

Risks

Regulatory changes

• Significant changes in the regulatory framework that could benefit or pose a risk to the Group’s financials.
  

Service disruptions

• Further train service disruptions leading to higher repair/ maintenance costs, operating expenses and regulatory fines.
  

Oil price spike

• Energy and fuel costs account for about 12% of SMRT’s costs and a surge in oil price may impact margins and vice versa. The surge in oil price may have a greater impact on SMRT compared to CD (at thisjuncture), given the latter’s proactive stance in hedging.

Riding high

• 3Q15 results in line; net profit up by 59% y-o-y
  
• Fare business segments turned in positive EBIT as expected
  
• Sustained low oil price could provide further tailwind for operating results
  
• Maintain BUY, TP: S$1.90
  

Highlights

3Q15 net profit tracking well

• 3Q15 net profit was higher by 59% y-o-y to S$22.6m, driven by revenue growth of 6.8% and lower increase in operating expenses (+4.2%). The higher costs were due to depreciation (+14%), repair and maintenance (+7%) and other operating expenses (+10%), offset by lower electricity and diesel costs (-7.3%). Staff costs increased only marginally by 0.6%. 9M15 net profit accounts for 72% of our forecasts, similar to last year.
  
• The 10.6% q-o-q fall in net income was largely due to a smaller EBIT contribution from taxis (S$0.8m, vs S$3.4m in 2Q15), which we understand to stem from non-recurring write-offs from some early retirements within its fleet. We should see taxis’ contribution revert to normal in 4Q15.
  

Fare business turned in profits vs losses last year

• Fare business turned around with a positive EBIT of S$1.9m, compared to a loss of S$8.9m in 3Q14. The major reversal is a result of significantly lower losses from bus operations at –S$0.5m, vs loss of S$8.7m last year, and is tracking within our expectations.
  
• Non-fare segments continue to perform well with rental remaining as the main EBIT contributor.
  

Outlook

Recently announced fare increase to provide support

• The Public Transport Council (PTC) has just approved a 2.8% fare increase effective 5 April’15, and this should provide support to its bottomline. We have factored this in, and are currently projecting a 22% net profit growth in FYE Mar’16F. We have also pencilled in a 1% fare decline in 2016.
  

Benefits from low oil price to continue

• Oil prices have corrected to below c.US$50/bbl from above US$100/bbl just about six months ago. We expect SMRT to continue to benefit through lower diesel and electricity costs. Assuming oil price continues to stay low at current levels, this should provide further benefit to land transport operators.
  

Bus tender outcome should not pose much downside risks

• The Government Bus Contracting tender for the first package (“Bulim package”) closed on 19 Jan’15, and the results are expected to be out in 2Q15. We have already factored in the incumbents (SMRT/SBSTransit) not winning the competitive tenders and just retaining nine out 12 packages.
  

Valuation

Our target price of S$1.90 is based on the average of our discounted cash flow (DCF) and price-earnings ratio (PER) valuation methodology. We adopt a DCF model as the business has previously shown a stable and predictable pattern, while the PER methodology takes into account near term earnings volatility. We peg our PER valuation at 18x FY16F. DCF methodology is based on a weighted cost of capital at 5.2% and a terminal growth assumption of 1%.

Risks

Regulatory changes

• Significant changes in the regulatory framework that could benefit or pose a risk to the Group’s financials.
  

Service disruptions

• Further train service disruptions leading to higher repair/ maintenance costs, operating expenses and regulatory fines.
  

Oil price spike

• Energy and fuel costs account for about 12% of SMRT’s costs and a surge in oil price may impact margins and vice versa. The surge in oil price may have a greater impact on SMRT compared to CD (at thisjuncture), given the latter’s proactive stance in hedging.

3QFY15 results reinforces positive outlook

• Solid 3QFY15 performance
  
• Lower oil prices to help
  
• Raise FV; maintain BUY
  

Good showing from 3QFY15 results

SMRT continued its recovery momentum with a set of solid 3QFY15 results. Its 3QFY15 PATMI jumped 58.4% YoY to S$22.5m on the back of a 6.8% broad-based revenue growth to S$313.2m. 3QFY15 operating profit grew 54.4% YoY to S$31.0m. The fare business continues to show solid growth on higher ridership and average fares as well as lower diesel costs but these gains were partially offset by higher depreciation from a larger train fleet and mandatory contribution to the public transport fund. As for the non-fare business, it improved mainly on higher rental income as a result of higher rental renewal rates of commercial spaces but was partially offset by early retirement of taxis. The sustained strong performance for all three quarters led to a 56.0% YoY increase in its 9MFY15 PATMI to S$70.2m, which formed 76.5% of our slightly more conservative FY15 forecast.

Profitability to improve on lower diesel costs

Our view on SMRT’s outlook remains positive on several factors: 1) its ability to consistently manage expenses since 1QFY15 reflects the measures taken are likely sustainable, 2) management though tightlipped on hedging position, stated electricity costs will continue to decrease; we believe that their FY16 diesel needs are largely exposed and hence should see further reduction in costs as well, 3) management also stated full contribution of rental income from Kallang Wave Mall is likely to materialize only from FY16 onwards, and hence we change our assumption of full contribution from 2HFY15 to FY16 onwards, 4) the taxi segment is likely to see higher growth with newer fleet commanding higher rental income though early retirement of taxis eroded 3QFY15 EBIT by 48.0% YoY to S$0.8m, 5) LTA’s purchase of SMRT’s bus assets in order to switch to the new bus contracting model could potentially see lump sum cash inflow to SMRT, leading to a possible special dividend or acquisition for growth. However, with no details announced, we have yet to factor this into our model.

Raise FV; maintain BUY

Based on the above factors, we increase our FY15 and FY16 PATMI forecasts by 4.1% and 15.3%, respectively, as we believe lower energy costs will drive up profitability at least in FY16. Consequently, our DDM-derived FV increases from S$1.70 to S$1.90. Maintain BUY.