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.
ComfortDelgro – OCBC
Key beneficiary of policy change
- Local bus operations a drag
- Good position to win tenders
- Preferred pick within sector
Core Singapore bus operations loss making since FY11
ComfortDelGro’s (CDG) core Singapore bus operations (operated via its 75%-owned subsidiary SBS Transit) has been a drag to its financial performance, raking in losses ranging from S$6-15m per year since FY11. During its recent 1Q14 results, CDG once again reported an operational loss of S$4.7m for its local bus business (excluding advertising and rental income), although this was an improvement from the S$5.4m loss suffered in 1Q13. The main issue is the lack of a commensurate increase in fare adjustments (last increase came in 2011 prior to the recent 3.2% increase implemented on 6 Apr 2014) despite heightened operating requirements from a growing population.
Brighter days ahead
Following LTA’s decision to implement a “Government gross cost contracting model”, we expect more significant improvements in its bus operations ahead, although the financial impact will only be felt in 2H16. As one of the Government’s objectives is to inject more competition into the industry, CDG comes under risk of losing its market share (~75%) since ~20% of existing buses will be put up for competitive tender in 2H14 (implementation will only take place in 2H16). Nevertheless, we believe CDG’s strong knowledge of the local operating environment and experience in operating a gross cost contracting model for its UK and Australia bus businesses will put it in a good stead to clinch the upcoming tenders.
Maintain BUY
CDG generated an operating margin of 8.4% and 19.2% for its UK and Australia bus businesses in FY13, respectively. LTA said that it has studied the London and Australian bus contracting models over the past two years, and hence we believe CDG will use these two countries as a benchmark, especially its UK operations, when it submits its tenders. Despite keeping our FY14-15 forecasts intact, we raise our FY16-18 PATMI projections by 4-12%, based on an 8% operating margin assumption for its Singapore bus operations. Consequently, our DDM-derived fair value is raised from S$2.30 to S$2.56. Maintain BUY. CDG remains as our preferred pick within the land transport sector.
ComfortDelgro – OCBC
Key beneficiary of policy change
- Local bus operations a drag
- Good position to win tenders
- Preferred pick within sector
Core Singapore bus operations loss making since FY11
ComfortDelGro’s (CDG) core Singapore bus operations (operated via its 75%-owned subsidiary SBS Transit) has been a drag to its financial performance, raking in losses ranging from S$6-15m per year since FY11. During its recent 1Q14 results, CDG once again reported an operational loss of S$4.7m for its local bus business (excluding advertising and rental income), although this was an improvement from the S$5.4m loss suffered in 1Q13. The main issue is the lack of a commensurate increase in fare adjustments (last increase came in 2011 prior to the recent 3.2% increase implemented on 6 Apr 2014) despite heightened operating requirements from a growing population.
Brighter days ahead
Following LTA’s decision to implement a “Government gross cost contracting model”, we expect more significant improvements in its bus operations ahead, although the financial impact will only be felt in 2H16. As one of the Government’s objectives is to inject more competition into the industry, CDG comes under risk of losing its market share (~75%) since ~20% of existing buses will be put up for competitive tender in 2H14 (implementation will only take place in 2H16). Nevertheless, we believe CDG’s strong knowledge of the local operating environment and experience in operating a gross cost contracting model for its UK and Australia bus businesses will put it in a good stead to clinch the upcoming tenders.
Maintain BUY
CDG generated an operating margin of 8.4% and 19.2% for its UK and Australia bus businesses in FY13, respectively. LTA said that it has studied the London and Australian bus contracting models over the past two years, and hence we believe CDG will use these two countries as a benchmark, especially its UK operations, when it submits its tenders. Despite keeping our FY14-15 forecasts intact, we raise our FY16-18 PATMI projections by 4-12%, based on an 8% operating margin assumption for its Singapore bus operations. Consequently, our DDM-derived fair value is raised from S$2.30 to S$2.56. Maintain BUY. CDG remains as our preferred pick within the land transport sector.
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).
SATS – Maybank Kim Eng
Await better entry point
- 4QFY3/14 net income of SGD42.6m (-7.8% YoY) fell short of market expectations due to elevated labour costs.
- The other disappointment: Lower-than-expected full-year DPS of 13 SGD cts (FY3/13: 15 SGD cts).
- Downgrade to HOLD with lower TP of SGD3.30 in view of near-term challenges that could cap share price upside.
What’s New
SATS reported 4QFY3/14 net income of SGD42.6m (-7.8% YoY), which was below market expectations. Labour costs remained the key pressure point in 4QFY3/14, rising 5.3% YoY due to tight labour market in Singapore and Hong Kong. Full-year DPS was lowered to 13 SGD cts from 15 SGD cts (of which 4 SGD cts was special) translating to an 81% payout. Despite growth in workload, operating profit for the Gateway Services segment weakened to SGD13.8m in FY3/14 (-34%), while Food Solutions segment declined by a smaller quantum of 11% to SGD141.9m. The outlook appears mildly negative with management blaming it on rising costs and the overcapacity issue in the regional aviation market.
What’s Our View
While SATS remains a good exposure to the Changi Airport expansion story, we believe near-term earnings will remain weak as it struggles to contain escalating costs. While initiatives to reduce labour dependency are positive, they are unlikely to result in any material near-term benefits. The persistently weak air freight market will continue to weigh on its operations in Singapore and associates that are highly geared to the cargo business. Hence, we lower our FY3/15-16E EPS forecasts by 8%/7% and see significant downside risk to consensus estimates. Accordingly, we trim our DCF-based TP to SGD3.30 (WACC = 7.6%, tg= 1.0%) from SGD3.47 previously and downgrade our rating to HOLD. However, we see limited share price downside at 4% dividend yield, which is supported by its net cash position.