First look

SMRT posted a 24% y-y rise in 2Q FY10 net profit to S$52.8mn, well ahead of our and consensus estimate of S$39mn. Higher rail margin and profits, other operating income and a lower tax rate were key reasons for the strong results. While management has guided for higher costs in 2H FY10, on the back of higher electricity rates and interest costs, we expect to adjust our FY10F upwards given the strong performance in 1H FY10. Maintain a BUY with a PT at S$1.96.

2Q FY10 well ahead

2Q FY10 results: strong rental and non-operating income cushioned CCL losses

• Net profit surprised on the upside, helped by better rental and nonoperating income: 2Q FY10 net profit of S$52.8MM (+24.1% Y/Y) was significantly above expectations, bringing 1H10 net profit to S$101MM. This strong set of results was helped by robust rental and non-operating income from maintenance and related contracts.

• Train ridership growth slowed, CCL losses prevail: Ridership was up by a mere 2.2% for the quarter even after incorporating CCL Stage 3 contribution. Operating profit of the train segment was 7% higher, attributed to the non-operating income contribution of S$8.5MM. Stripping that out, operating profit of the train segment actually declined 16% Y/Y. This translates into an estimated loss of S$6MM for the CCL this quarter, in line with our loss estimate. Stages 1 & 2 will open in 1H CY10 and Stages 4 & 5 in 2011.

• Rental business prospects exciting: Operating profit from the rental business increased 10.8% on the back of increased rental space and better yield. The company will refurbish three more Xchanges in FY11 and FY12 – Jurong East (+2,500sqm), Orchard (+1,600sqm) and Esplanade (+2,000sqm), potentially increasing the lettable space by another 20% in the next two years. Rental now accounts for 21% of total operating profit and looks set to increase going forward.

• First foray overseas set to go: SMRT completed its 49% acquisition of Shenzhen Zona. The associate will start contributing in 3Q10. Management expects Zona’s profit after tax in 2010 and 2011 to at least more than double the Rmb24MM in 2008, based on existing fleet size alone, due to lower interest expense. Management expects Zona’s profit contribution to be material in five years’ time.

• Maintain Neutral, raise Dec-10 PT to S$1.90: We raise our earnings estimates by 23%/24%/27% for FY10/FY11/FY12 to incorporate the potential rental contribution from the three new refurbished Xchanges, fare reversion post-June 2010 when the current fare reduction expires, as well as associate earnings contribution from Zona. As a ersult, we increae our Dec-10 PT to S$1.90.

Lower energy costs boosted margins

2QFY10 results above expectations. 2QFY10 registered net profit of SGD52.8m, up 24.1% YoY (+9.5% QoQ), or 31.4% of our full year forecast. The variance was due to lower staff costs which fell 1.1% compared to our forecast of +10.4% as well as the 16.9% decline in energy cost. Operating profit rose 20.1% YoY boosted by MRT (+7%), bus (+272%) and retail rental (+11%). We raise our FY10 net profit by 9% to S$183m from S$168m while maintaining our TP at S$2.00.

Ridership growth still sluggish; stronger growth expected in FY11. Between Jan-Sep, SMRT’s daily rail ridership rose a mere 3.2% YoY to 1.42m. We are, however, upbeat that ridership figures could be stronger next year on the back of stronger economic and tourism growth. The Circle Line will be fully operational in 2011, which will be the gateway to the two Integrated Resorts. We forecast rail ridership growth of 4% in FY10 and a stronger 10% in FY11, in anticipation of positive spin offs from these resorts which will radiate tourists and locals alike towards these locations.

Higher operating expenses expected in 2HFY10. Management cautioned that 2HFY10 profitability will be impacted by the 11% increase in electricity tariff which has been contracted for the period between 1 Oct 2009 and 30 Sep 2010. Apart from higher energy costs, management expects operating expenses to rise due mainly to more scheduled repairs and maintenance, and higher staff and related costs as headcount is expected to be higher with the operation of Circle Line Stage 3, increased train runs and recruitment of bus service leaders.

At its lower range of its 14-20x trading band. SMRT currently trades at ~14x FY10 P/E multiple which is at the lower range of its 14-20x trading band. We view SMRT as an ideal switch play for investors with a defensive mandate, given the 7-month market surge. SMRT has a low beta of 0.45x and strong earnings resilience underpinned by a firmer economic outlook. At our TP of S$2.00, SMRT will trade at an FY10 P/E multiple of 16.5x, a reasonable peg in our view. An interim dividend of 1.75¢ per share was declared for 2QFY10.

SMRT Capital’s debut $150m note issue well received

Orderbook closed within half hour of launch with 2 times oversubscription

The debut $150 million note issue of SMRT Corp’s wholly owned subsidiary, SMRT Capital, has attracted strong demand.

‘Strong interest from bond investors resulted in the orderbook being more than two times oversubscribed and closed within half an hour of the launch of the notes,’ SMRT said yesterday.

The five-year 2.42 per cent fixed rate notes are issued under SMRT Cap’s $1 billion multi-currency guaranteed medium term note programme and are expected to be issued on Oct 7 and mature in 2014. SMRT guarantees the servicing of the notes. Hongkong and Shanghai Banking Corporation acted as sole lead manager and bookrunner of the notes and sole arranger of the programme.

The programme has been rated AAA by Standard & Poor’s.

The net proceeds arising from the issue of the notes will be used to finance the general corporate funding requirements of SMRT and its subsidiaries.

The issue of the notes represents SMRT Cap’s debut visit to the bond markets and is the first bond issue from the SMRT group since December 2006.

The deal was priced on Wednesday at about 10 basis points above the five-year Singapore-dollar Swap Offer Rate, the tightest five-year pricing for a Singapore domiciled corporate since January 2007.

Executive vice-president and chief financial officer for SMRT Corp Lim Cheng Cheng said: ‘We are very pleased with the keen investor response to our issue. This issue helps us re-establish SMRT’s presence in the Singapore-dollar bond markets in a very positive manner.’

Amit Gupta, managing director and head of global markets for HSBC in Singapore, said: ‘We are privileged and honoured to have brought a premium institution like SMRT to the Singapore-dollar bond market. By leveraging on HSBC’s strong capital markets platform and local knowledge, we were able to execute a broadly distributed transaction for SMRT Capital at the tightest five-year pricing level achieved in the Singapore-dollar bond market since January 2007.’

Temasek-linked companies (TLCs) have been on a fund-raising spree over the past few months as they take advantage of a recovering economic outlook to tap the financial markets to build up war chests ahead of potential future deals. For some, such a move will also improve their debt positions.

Six TLCs have raised a massive $10.5 billion from rights issues since December.

In July, SMRT said it is acquiring a 49 per cent stake in Shenzhen transport company Shenzhen Zona Transportation Group for 320 million yuan (S$68 million). SMRT said its first investment in a Chinese company is a beachhead for its expansion into China. SMRT said at its Q1FY10 results briefing that it sees a tough year ahead with continued volatility in diesel prices, the effects of the fare reduction package and the ramp-up costs for the opening of the remaining Circle Line stations.

Ridership figures could have a lag in the recovery in GDP

Weak start at Circle Line due to poor connectivity however mgmt expects impact to be minimal. SMRT average daily rail and bus ridership in Aug09 grew by 1.6% YoY and -1.2% YoY to 1.4m and 0.8m, respectively. The trend has been weaker than expected due to poor ridership at its core North East South West (NSEW) lines as a result of the slowing economy. In addition, ridership at Circle Line (CCL) has been below our expectations of 55k in average daily ridership. Stripping out CCL ridership of more than 30k in average daily ridership, the core ridership at NSEW lines would have declined by 0.5% YoY. YTD SMRT’s ridership for rail grew at 2.6% YoY and bus at -0.7% YoY.

Revised our ridership forecast downwards. We have revised our FY09E ridership forecasts for rail from 6.4% YoY to 3.5% YoY and bus from 0.8% YoY to -0.5% YoY. We have revised our earnings downwards by 2-3% in FY10-12E to account for the lower ridership in our forecasts partially offset by higher rental revenue assumptions (due to the redevelopment of five MRT stations), lower staff costs, lower depreciation and higher EBIT contribution from bus and taxi divisions.

Lowered our TP from S$2.05 to S$2.00; Buy. SMRT offers a defensive yield of 5.0%. Our revised target price is based on our DCF valuation using a COE of 7.5% and a TGR of 1.0%. Our S$2.00 TP implies a PE of 17.0x FY10E. Downside risks: rebound in the oil price, lower ridership, reduction in fares, taxi competition and disease outbreak.