UOB Kay Hian 2015-08-05: Sector Update - Land Transport − Singapore Earlier-than-expected Fare Review.

Land Transport − Singapore Earlier-than-expected Fare Review 


  • A Surprise The Transport Minister announced that public transport fares will be reduced by up to 1.9% from Dec 15, citing falling fuel costs. 
  • This fare review is earlier than expected and is likely to have a greater impact on SMRT than CD. 
  • In addition, we note that the adjustments in bus fares will be immaterial post 3Q16 given the transition into an asset-light bus contracting model. 
  • ComfortDelGro remains our preferred pick. 


WHAT’S NEW 


  • Transport Minister Lui Tuck Yew announced that public transport fares will be reduced by up to 1.9% from Dec 15, citing falling fuel costs. This fare reduction will be based on an overall level and might have different weightages for the various operating segments (ie bus, train and LRT). This note highlights our analysis and key takeaways from our channel checks. 


ESSENTIALS 


 Fare review earlier than expected. 

  • The earlier-than-expected reduction in fares will lower revenue for both public transport operators’ (PTOs) bus and rail segments. This announcement comes as a surprise as the latest fare revision was only done recently in Apr 15. 
  • In addition, we were expecting a muted fare growth in 2016 as compared with the proposed maximum fare reduction of -1.9%. 
  • We note that the last fare reduction was in 2009 when the public transport operators forewent their applications for a fare adjustment as the Singapore Land Transport sector moved towards a distance-based fare structure. 

 Greater earnings impact for SMRT compared with CD. 

  • Since fares would be reduced by up to -1.9%, we did a sensitivity analysis on 2016 earnings. 
  • At a maximum fare reduction of -1.9%, we are expecting the impact on SMRT’s and CD’s earnings to be - 12.3% and -7.0% respectively. 
  • We attribute the lower impact on CD’s earnings to its overseas diversification. CD derives about 45% of its operating profit from overseas while SMRT has majority of its core operations in Singapore. 

 Fare reduction led mainly by lower fuel costs. 

  • The fare formula implemented by the Public Transport Council consists of changes in the Core Consumer Price Index, the Wage Index and the Energy Index over the preceding year. 
  • We note that crude oil prices declined below US$60 a barrel for the first time in five years and that the change in Energy Index (which is a composite of cost changes in electricity and diesel) for the last review was -12.6%. 

 Fare risks are mitigated under the government contracting model. 

  • The impact on CD’s earnings is further mitigated by the transition into the asset-light bus contracting model. 
  • Given that CD has more than 50% of revenue exposure to bus operations as compared with SMRT’s 19%, we expect less fare risk exposure for CD once the bus operations transit into a contracting model in 2016. 
  • On the contrary, rail revenue contributes more than 50% to SMRT’s revenue and we do not expect the restructuring of the rail infrastructure (Rail Financing Framework) to happen in the near term. 
  • Hence, we note that the adjustments in bus fares will not impact the PTO’s bus segments post 3Q16 as both the incumbents will be operating on a cost-plus model. 

 The impact on valuations will be minimal.

  • Given the worst-case scenario of a - 1.9% fare reduction, the target price for SMRT will be S$1.21 and CD will be S$3.27. 
  • Given that the Transport Minister Lui Tuck Yew has stated that the exact level of fare reduction is not yet certain, we have not taken the -1.9% fare reduction into our valuations. 
  • We will continue to keep up with developments and update accordingly. 

 CD still preferred. 

  • We pick CD over SMRT due to CD’s diversified earnings stream and stronger financial position. 
  • CD is trading at a current 2015F PE of 20.3x, a slight discount to SMRT, which is trading at PE of 20.7x. 
  • We note that despite CD’s slightly cheaper valuations, the group’s expected 2015 ROE of 14.0% is higher than SMRT’s 10.9%.





Analyst: Bennett Lee, CAIA; Andrew Chow, CFA

Source: http://research.uobkayhian.com/


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