CIMB Securities 2015-08-04: Public Transportation Sector - Impact from fare reduction. Add CDG, Reduce SMRT.

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Impact from fare reduction 

• Transport Minister, Mr. Lui Tuck Yew, has announced a fare reduction of up to 1.9%, effective by end-15, to account for the lower fuel prices. 
• While the specific size of the reductions has yet to be finalised by the Public Transport Council (PTC), we conduct a sensitivity analysis to show the potential impact of the fare cut on CDG and SMRT. 
• In the worst-case scenario (i.e. the 1.9% fare cut), CDG’s FY16-18 core EPS estimates are cut by 2.4%, 0.7% and 0.8% respectively, while SMRT’s FY16-18 estimates are cut by 4.1%, 11.5% and 8.6%, respectively. 
• CDG’s DCF-based target price is cut from S$3.42 to S$3.39 and SMRT’s from S$1.42 to S$1.28. 
• CDG remains an Add and SMRT a Reduce. 
• We maintain Overweight on the sector on account of its structural reforms. 

What Happened 

• During his meeting with reporters at a preview of the new Circle Line trains on Monday 3 Aug, Mr. Lui announced a fare reduction of up to 1.9% by end-15, affecting public train and buses fares, to account for the lower fuel costs. 
• The specific size of the cut would be determined by PTC. 

What We Think 

1. The announced fare reduction would have a negative impact on the profitability and valuations of both CDG and SMRT, assuming that everything else holds equal. 
2. As shown in the table above, the potential impact of fare reductions would hit the core EPS estimates and the valuation of SMRT harder than CDG due to the following reasons: 
   1. over 70% of SMRT’s revenue is derived from Singapore public train and bus services (train: 53% and bus: 28% of FY3/15 revenue), while CDG’s effective revenue exposure to Singapore trains and buses is below 20% (train: 4% and bus: 15% of FY12/14 revenue) due to its better business diversification locally and globally;
   2. effective from Aug 16, the Singapore public bus would be operated under a new Government Contracting Model (GCM), under which the government would bear all the fare risk while the bus operators would be compensated by a fixed contract fee (plus bonus/penalty subject to performance); hence the profitability of Singapore’s public bus operations would no longer be subject to variation in fare revenue.
3. Potential rail reform towards a similar contracting model could free SMRT and CDG from the fare risk of the rail transportation; however, there has not been a clear timeline for the rail reform. 

What You Should Do

• For conservative purposes, we use the maximum 1.9% fare cut for our core EPS estimates and derive lower target prices of S$3.39 for CDG (Add) and S$1.28 for SMRT (Reduce). 
• The sector remains an Overweight, with the structural reform being a key potential catalyst. 
• CDG is our top pick for its business diversification, overseas growth initiatives and stronger balance sheet. 

Analyst: Roy CHEN; William TNG, CFA

Source: http://research.itradecimb.com/