Maybank Kim Eng Research 2015-08-05: Land Transport Sector on Fare Cuts - SELL SMRT, ComfortDelgro.

Fare Cuts to Hurt SMRT More; D/G 

  • Transport Minister said bus & rail fares could be cut by 1.9% by end-2015. 
  • We see limited impact on buses, which would transit to a fare-independent model by Sep 2016. 
  • In contrast, fare cuts could magnify rail losses at SMRT. Downgrade SMRT to SELL from HOLD with new SGD1.10 TP (from SGD1.57). Estimate minimal impact for ComfortDelGro (TP SGD2.70), though we maintain SELL. Cut sector to UNDERWEIGHT from Neutral. 

What’s New 

  • Transport Minister Lui Tuck Yew said that bus and rail fares could be reduced by 1.9% by end-2015 (link), as oil prices have been declining in the past year. 
  • Recall that annual fare changes are guided by a formula, which takes into account inflation, wages and energy costs. Fares were most recently raised by 2.8% in Apr 2015. 
  • Fare-adjustment formula = 0.4*cCPI + 0.4*WI + 0.2*EI - 0.5%, where cCPI= Core Consumer Price Index, WI= Wage Index, EI= Energy Index. 

What’s Our View 

  • As we make the transition to a fare-independent Government Contracting Model for bus operations by Sep 2016, we believe that fare changes will have a minimal impact on bus profitability. 
  • In contrast, as rail operations are still dependent on fare revenue, we believe that the fare cuts will affect rail profitability. 
  • SMRT has bigger rail exposure than ComfortDelGro, with rail at 53% of its revenue vs only 5% for the latter. 
  • The suggested cuts are larger than our initial estimate for a cut of 1%, though lower oil prices would also provide some cost relief. 
  • SMRT’s 1QFY3/16 results suggest that its costs have been going up to support an ageing network, a larger train fleet, tightened regulatory standards and heightened operational demands. 
  • As these are not captured by the government’s fare-adjustment formula, we expect fare cuts to have a magnified impact on its rail profitability. 
  • We slash our FY16-18 EPS by 33%. With the timing and details of any rail transition remaining hazy, we expect the market to focus on its weakening profits. 
  • We downgrade SMRT to SELL with a new TP of SGD1.10 (from SGD1.57), still based on 20x FY3/16 EPS, 1SD above its 10-year average. 
  • Maintain SELL on ComfortDelGro on challenges to its taxi business and AUD weakness.

Analyst: Derrick Heng, CFA

Source: http://www.maybank-ke.com.sg/