Category: SMRT
Land Transport – CIMB
Cool winds of change
With changes to the public bus system just announced by the government, both CD and SMRT can expect to eliminate operating losses in this segment of their business and improve their cash flow through lower capex and asset disposals. Conventional thinking favours CD (Add, target S$2.59) as the biggest winner, owing to its larger bus fleet and experience with cost-plus models, but we think that SMRT’s (upgraded to Add, target S$1.67) performance will also improve, as this development could serve as a prelude to a new rail financing framework. We upgrade the sector to Overweight from Underweight, with catalysts from more government initiatives and SMRT as our top pick.
What Happened
The government is revamping Singapore’s public bus industry to a “government contracting model”, starting 2H14. Under the new system, the government will own all bus infrastructure (depots, buses and systems).
Implementation only in 2H16. Initially, LTA will tender out three packages of bus services (out of a total of 12), starting with the first package in 2H14, for implementation in 2H16. The three packages will cover 20% of the existing buses. LTA will negotiate with the incumbents to run the remaining nine packages (80% of existing buses) under the contracting scheme, for durations of about five years when their Bus Service Operating Licences (BSOLs) expire on 31 Aug 16. After their expiry, more bus services will gradually be tendered out. The contracts will be valid for 5+2 years.
What We Think
The devil is in the detail. Details of the first bus package will be out next week. After 2022, all packages will be tendered out, with the aim of having at least 3-5 bus operators in the market. While some numbers regarding margins, the transfer of assets to the government and contracting are not out yet, we have made certain assumptions for CD and SMRT, to estimate the impact on their earnings, balance sheets and fleet-disposal plans to reflect these landmark changes.
Earnings upgrade; reduced capex and some disposal cash flows. Both Public Transport Operators (PTOs) should benefit from the transition to a more sustainable model, as this should ward off operating difficulties for them. CD, through SNS Transit, operates about 75% of Singapore’s 4,500 public buses, while SMRT runs the remaining 25%. CD’s Singapore bus business (19% of revenue) made a small operating profit of S$3.2m (only 1.8% EBIT margin and 3% of group EBIT) in 1Q14, while SMRT Buses (also 19% of revenue) incurred an operating loss of S$28.4m in FY14. CD’s bus assets on its books are valued at c.S$820m and SMRT’s, at S$250m. While EBIT margins for both may not spike immediately, both certainly have advantages over any new competitor, given their extensive knowhow and track record in running public buses in Singapore.
What You Should Do
Sector upgraded to Overweight. We keep our Add rating for CD with a higher DCF-based target price (WACC 7.1%) after upgrading our earnings. It should be a clear beneficiary of the most significant development in the local bus industry in recent times. We upgrade SMRT to Add from Hold, given its greater earnings sensitivity to this move (see separate notes on CD and SMRT).
Land Transport – CIMB
Cool winds of change
With changes to the public bus system just announced by the government, both CD and SMRT can expect to eliminate operating losses in this segment of their business and improve their cash flow through lower capex and asset disposals. Conventional thinking favours CD (Add, target S$2.59) as the biggest winner, owing to its larger bus fleet and experience with cost-plus models, but we think that SMRT’s (upgraded to Add, target S$1.67) performance will also improve, as this development could serve as a prelude to a new rail financing framework. We upgrade the sector to Overweight from Underweight, with catalysts from more government initiatives and SMRT as our top pick.
What Happened
The government is revamping Singapore’s public bus industry to a “government contracting model”, starting 2H14. Under the new system, the government will own all bus infrastructure (depots, buses and systems).
Implementation only in 2H16. Initially, LTA will tender out three packages of bus services (out of a total of 12), starting with the first package in 2H14, for implementation in 2H16. The three packages will cover 20% of the existing buses. LTA will negotiate with the incumbents to run the remaining nine packages (80% of existing buses) under the contracting scheme, for durations of about five years when their Bus Service Operating Licences (BSOLs) expire on 31 Aug 16. After their expiry, more bus services will gradually be tendered out. The contracts will be valid for 5+2 years.
What We Think
The devil is in the detail. Details of the first bus package will be out next week. After 2022, all packages will be tendered out, with the aim of having at least 3-5 bus operators in the market. While some numbers regarding margins, the transfer of assets to the government and contracting are not out yet, we have made certain assumptions for CD and SMRT, to estimate the impact on their earnings, balance sheets and fleet-disposal plans to reflect these landmark changes.
Earnings upgrade; reduced capex and some disposal cash flows. Both Public Transport Operators (PTOs) should benefit from the transition to a more sustainable model, as this should ward off operating difficulties for them. CD, through SNS Transit, operates about 75% of Singapore’s 4,500 public buses, while SMRT runs the remaining 25%. CD’s Singapore bus business (19% of revenue) made a small operating profit of S$3.2m (only 1.8% EBIT margin and 3% of group EBIT) in 1Q14, while SMRT Buses (also 19% of revenue) incurred an operating loss of S$28.4m in FY14. CD’s bus assets on its books are valued at c.S$820m and SMRT’s, at S$250m. While EBIT margins for both may not spike immediately, both certainly have advantages over any new competitor, given their extensive knowhow and track record in running public buses in Singapore.
What You Should Do
Sector upgraded to Overweight. We keep our Add rating for CD with a higher DCF-based target price (WACC 7.1%) after upgrading our earnings. It should be a clear beneficiary of the most significant development in the local bus industry in recent times. We upgrade SMRT to Add from Hold, given its greater earnings sensitivity to this move (see separate notes on CD and SMRT).
SMRT – CIMB
Out of the dark tunnel
We raise SMRT’s FY17 EPS by 13% to incorporate its higher earnings sensitivity to the new government contracting model for buses, which lifts our DCF-based target price (WACC 7%). Other potential re-rating catalysts are better earnings from cost-control measures. We also suspect that this new bus model is a prelude to a rail financing model. Given further positive news flow expected, we upgrade the stock from Hold to Add.
What Happened
The government is revamping Singapore’s public bus industry to a “government contracting model”, starting 2H14. Under the new system, the government will own all bus infrastructure (depots, buses and systems). Implementation starts only in 2H16 (details overleaf).
What We Think
Better earnings, also cash flow and balance sheet. More details will be unveiled next week with the announcement of the first bus package. SMRT’s Singapore bus business in FY14 contributed S$217.8m in revenue (19% of total revenue) but lost S$28.4m at the operating level. If its operating margins eventually mirror those of bus operators in Australia and the UK, at 10-17%, SMRT’s bus EBIT margin as a whole can shift up to a conservative 7% in FY17 and 12% by FY18, in our estimation, from current negative territory. We are assuming reduced capex spending of 20% for FY16 and 47% for FY17 and asset disposals of c.S$25m in FY17. Net gearing should fall to 27% by then. FY17 EPS could be lifted by 13%, simply from larger revenue contributions and the elimination of bus operating losses.
What You Should Do
Upgrade to Add. Contrary to conventional thinking, we think that the bigger beneficiary should be SMRT, as it is the one with greater earnings sensitivity to the changes. Added to this is a new rail financing framework under discussion, with the earlier-than-expected move on the bus model serving as a prelude to the rail model. All these change our mind on the stock and we upgrade it to Add.
SMRT – OCBC
Clearer skies ahead
- Fare business in the red
- Awaiting rail financing framework updates
- Bump up FV but maintain HOLD
More positive outlook following policy change
Operating profits for SMRT’s fare business (Bus, LRT and MRT) has been on the downtrend since FY09. This even slipped into the red in FY14, with an operating loss of S$25.0m registered, versus an operating profit of S$32.3m in FY13. The main drag came from its Bus operations, which recorded an operating loss of S$28.4m, while its Train business also experienced a 91.6% plunge in operating profit to just S$5.5m in FY14. We believe the transition of the public bus industry towards a “Government contracting model” will help to alleviate the pressures for the operators such as SMRT, as the revenue risk will now fall under the Government. This new model will allow SMRT to return to profitability for its bus operations in FY17, based on our estimates.
Rail financing framework could be implemented next
Following the implementation of the “Government contracting model” for buses, we believe there are now stronger expectations for updates from the Government on the rail financing framework. Assuming LTA does intend to own the rail infrastructure and operating assets (as was the case for Downtown Line), SMRT would stand to benefit more than ComfortDelGro as the latter does not carry any rail assets on its balance sheet. Based on our estimates, the net book value of SMRT’s rail assets is worth ~S$1b. If the sale of these assets back to the Government does eventually materialise, it would strongly bolster SMRT’s balance sheet. We have not factored in this scenario in our model.
Maintain HOLD
Switching our focus back to the new bus contracting model, we retain our FY15-16 forecasts but raise our FY17, FY18 and FY19 PATMI projections by 7.9%, 13.4% and 12.3%, respectively. This bumps up our fair value estimate from S$1.25 to S$1.40. Given SMRT’s robust share price run-up in recent weeks, we believe these positives have been priced in. Hence, we maintain HOLD on SMRT.
Land Transport – OCBC
Another step towards sustainability
- “Government contracting model”
- Turnaround in operations expected
- CDG likely to benefit more than SMRT
Restructuring Singapore’s public bus industry
LTA announced that it will restructure the public bus industry to a “Government contracting model” beginning from 2H14 (but implementation to take place only in 2H16 after the expiration of the current Bus Service Operating Licenses on 31 Aug 2016). This is aimed at improving service quality and injecting more competition into the industry. The key implication of this is that revenue risk will now fall under the Government instead of the public transport operators (PTOs). Under this model, bus operators will bid for the right to operate bus services via a competitive tendering process. The Government will own all bus infrastructure and operating assets. We believe this means LTA may buy over existing bus assets from the PTOs in the future, although the timeline is unclear. The net book value of SBS Transit’s (75%-owned by ComfortDelGro) buses is S$817.5m (as at 31 Dec 2013), while that of SMRT is ~S$200m (as at 31 Mar 2014), based on our estimate. Three out of 12 bus packages (~20% of existing buses) will be tendered out starting from 2H14, and the contract length will be five years (can be extended by another two years on good performance). The remaining 80% of buses will continue to be operated by the incumbent operators, and these will also come under the new contracting model when their licenses expire on 31 Aug 2016 (five year tenure).
CDG to benefit more than SMRT
Overall, we believe this will enable the PTOs’ bus operations to return to profitability. During their most recent full-year results, ComfortDelgro (CDG) and SMRT reported operating losses of S$14.4m and S$28.4m, respectively, for their core Singapore bus operations (excluding advertising and rental income). We expect CDG to be a bigger beneficiary than SMRT as the former operates the largest bus fleet in Singapore (~75% market share via SBS) and also has experience operating a gross cost contracting model for its UK and Australia bus businesses. It generated an operating profit margin of 8.4% and 19.2% for these two areas in FY13, respectively. We believe a 6-9% operating margin can be achieved by the PTOs.
Upgrade sector to OVERWEIGHT
The Singapore Government’s initiative to move towards a gross cost contracting model is a positive paradigm shift which we believe will help to ensure the longer-term sustainability of Singapore’s public bus operations. Although the financial impact will only take place in 2H16, we believe efforts to improve productivity (PTOs’ bus losses have narrowed) and changes to the fare adjustment system will aid the sector’s recovery in CY14 and CY15. Hence we upgrade the land transport sector from Neutral to OVERWEIGHT. We maintain our BUY rating on CDG (FV lifted from S$2.30 to S$2.56) and HOLD rating on SMRT (FV lifted from S$1.25 to S$1.40).