OCBC Investment 2015-08-27: SMRT Corporation - Pricing-in of potential fare cut overdone

SMRT CORPORATION LTD S53.SI

SMRT Corporation: Pricing-in of potential fare cut overdone

 Up to 1.9% in potential fare reduction.

 Rail reform still a positive catalyst.

 Lower FV; reiterate BUY

Singapore’s Transport Minister announced on 3 Aug reduction in bus and train fares by up to 1.9% effective end-CY15 for a one-year period to reflect the lower energy costs. With the most recent fare hike of 2.8% effective Apr 15, this announcement of fare reduction within the same year came as a surprise to us.
With transition to bus government contracting model (GCM) (i.e. no revenue risk since SMRT will receive annual contract fee) only effective 2HCY16 and bus segment only making up ~20% of total revenue, we think the fare reduction is negative on SMRT’s growth in the near-term. With no concrete details announced, we remain conservative and incorporate worst-case scenario assumptions (i.e. 1.9% fare reduction) impacting SMRT’s 1QFY16 and 1QFY17 to 3QFY17 forecasts.
Consequently, our FY16/17F PATMI forecasts are reduced by 5%/9%, respectively.

We remain positive over the transition to the new rail financing framework (RFF) that will eventually occur. There are two perspectives over the timeline of the transition:
1. the recent spate of breakdowns requires SMRT to complete all renewals and upgrade of rail network (i.e. at least two to three years later) before any transition can take place, or
2. because both the LTA and SMRT have a common interest of ensuring minimal rail services disruption going forward, there is a possibility that the transition could be brought forward to an earlier date, as it puts SMRT in a better position (i.e. improved financial ability) to perform the rail network renewal.
However, without any concrete confirmation, we prefer to wait and have yet to factor any impact. For more details on RFF, refer to our Land Transport Sector reports dated 3 Dec 14 and 20 May 15.

Updating our forecasts and acknowledging near term weakness, our DDM-derived (risk-free rate: 2.6%; risk premium: 8.5%) FV drops to S$1.45 (prev: S$1.70).
Supported by the longer-term positive rail reform catalyst, reiterate BUY as we think the recent fall in share price is most certainly overdone, and current price level has become attractive with total upside of ~29%.

Eugene Chua | http://www.ocbcresearch.com/ OCBC Investment Research 2015-08-27

BUY Maintain BUY 1.45 Down 1.70