Sustained losses at fare business

• Disappointing quarter as expected, with net profit plunging 44% YoY to SGD14.2m.
  
• Combined operating loss of SGD9.0m for its fare business. Impending fare hike unlikely to be sufficient to offset losses.
  
• Structural headwinds from DTL cannibalisation yet to be priced in by the market. Maintain SELL with TP of SGD0.60.
  

What’s New

SMRT reported another disappointing set of numbers for 3QFY3/14, with net profit plunging 44% YoY to SGD14.2m. The combined operating loss for its fare-based business stood at SGD9.0m [MRT: SGD0.4m, LRT: (SGD0.6m), bus: (SGD8.9m)], reflecting the challenging business environment for public transport operators. On the bright side, 3QFY3/14’s rental profits improved 9.2% YoY to SGD18.5m, mitigating negatives at its core fare-based business. As of 9MFY3/14, capex of SGD604m has exceeded management’s previous guidance of SGD500m for the full year. Consequently, the company’s balance sheet deteriorated with net gearing climbing to 64% at end-2013 (Mar 2013: 8%).

What’s Our View

We maintain our negative view on the stock. While the fare increase from Apr 2014 would give SMRT an estimated net benefit of SGD13.2m pa, or SGD3.3m per quarter, we do not think this alone is sufficient to offset losses in view of the current run-rate of SGD9m per quarter for its fare business. Furthermore, SMRT faces the threat of cannibalisation when Stage 2 of the Downtown Line (DTL) opens in 2016, which puts approximately 17% of its fare revenue at risk (Figure 4). While transiting to a sustainable business model for its train and bus operations appears imminent, we argue that it is highly speculative to conclude that the transition terms will be favourable to shareholders. Our TP of SGD0.60 is based on 14x FY3/14-16E P/E. Maintain SELL.

Revenue-cost misalignment

Earnings were disappointing, no thanks to a nightmarish mix of higher opex and the lack of a fare hike. The only positives are that the risk of significant dividend cuts is lower now and management is proactive in growing its non-fare business domestically and overseas.

2QFY3/14 net profit was 34% short of our below-consensus estimate, with 1HFY14 making only 35% of our FY14 forecast. We reduce our FY14-15 forecasts by 6-30% to account for higher operating expenses. Maintain Underperform with a lower target price (DCF, WACC 6.5%) of S$1.06. De-rating catalysts are poor earnings from cost issues and the inability to navigate regulatory constraints.

Bottomline got hit again

Revenue rose 5.3% yoy, thanks to the strong ridership in Singapore. However, with relentlessly higher operating costs, 2QFY3/14 profit was dragged lower by 57% yoy. Costs escalated in several business segments. The large jump in costs was the result of a sharper rise in staff costs (+27% yoy), wage adjustment and higher headcount.

Higher opex but higher dividend payout ratio too

We increase all the key operating expenditure assumptions, although we think that staff costs should hover around this level for the rest of the year (c.40% of revenue). SMRT has proposed to pay an interim dividend of 1 Sct/share, a significant jump in payout ratio in this case. We believe the risk of further dividend cuts is now less of a concern given the more robust cash flow structure.

Revenue-cost misaligned

Fare adjustment remains a problem and revenue growth will still lag behind cost inflation. We believe that SMRT is making inroads with regulators regarding the accounting of asset transfers under the new rail-financing framework. Once this is resolved, the end result will be predictable cash flows and a more sustainable financing model, which will alter the fate of the company. Until then, the stock may continue to underperform.

Laying low

• Free-ride scheme increasing ridership
  
• Weakness priced in by the street
  
• A stable share price for now?
  

Rail ridership figures exceed 60m for first time

The free MRT ride scheme introduced on 24 Jun has seen rail ridership figures for Jul and Aug exceed 60m rides for the first time in SMRT’s history. The incentive to promote travel to 16 designated MRT stations in the city area before 8am has also aided in the alleviation of a congested rail system during the morning peak periods. In terms of financials, SMRT will bear the cost of free travel up to S$5m and the relevant authorities will compensate the company for the remainder.

More of the same for 2Q14 results

We expect SMRT’s upcoming 2Q14 results to be similar with 1Q14: slight revenue growth with higher operating expenses – namely staff, depreciation and repair/maintenance – causing operating profit to decline by doubledigits YoY. On a segmental basis, bus operations will likely extend its streak of 11 consecutive quarters of losses (but we assume no asset impairments); rail profitability will be lower as well. The taxi, rental and advertising segments should stay positive and provide some consolation to SMRT.

Upgrade to HOLD on valuation grounds SMRT is unlikely to see an uptick in its share price due to the lack of a fare increase (delay by the Fare Review Mechanism Committee) and pressures on operating expenses. However, since the end of Aug, SMRT’s share price has stabilised between a tight band of 1.29-1.30, which has helped to arrest its slide of 10% following its 1Q14 results. The lower frequency of bad publicity has definitely aided the company, and we believe that the street has already factored in the majority of the negative expectations for FY14 as well as concerns over capex requirements. As SMRT is currently trading close to our unchanged fair value estimate of S$1.30, we upgrade the counter to HOLD on valuation grounds ahead of its 2Q14 results release at the end of the month.