SMRT Corporation - UOB Kay Hian 2015-09-22: An Event-driven Play

SMRT CORPORATION LTD S53.SI

SMRT Corporation (MRT SP) - An Event-driven Play

SMRT’s share price rallied 14.1% from its ytd low. We think SMRT’s theoretical price should a rail restructuring take place is S$1.43-1.48 and this may throw up some interesting buying opportunities, given any price weakness. That said, we note there is little change in its fundamentals while the rail operating environment remains challenging.
Maintain HOLD and DCF-based target price of S$1.25. Entry price: S$1.14.

SMRT’s share price rallied 14.1% from its ytd low despite little change in its fundamentals while the rail operating environment remains challenging. However, post general elections in Sep 15, we think the rail financing framework is likely to gain traction as the government continues to improve Singapore’s public rail systems. We analyse the possible impact on SMRT should the rail financing framework take place.

In 2010, the rail financing framework (RFF) was introduced and was aimed primarily at facilitating future expansion of the Rapid Transit System (RTS) network in a financially sustainable manner and injecting greater contestability into the rail industry.
Post general elections in Sep 15 and with a much higher-than-expected share of popular votes, we expect the RFF to gain momentum as the government continues to improve Singapore’s public rail system. We note that among the rail lines, only the train assets* (net book value estimated at S$764m) on the North-South, East-West and Circle lines are owned by a public operator (SMRT) currently. ComfortDelgro (CD) does not own any rail assets and as a result, we think SMRT will be the prime beneficiary from any clarity on the RFF.
Other than the benefits of eliminating rail fare risk, we think a restructuring will considerably reduce SMRT’s annual depreciation and maintenance capex expenses while boosting its cash balance.

We estimate the rail financing framework could lead to a special dividend payout of 18.2-23.2 cents/share for SMRT shareholders. assuming:
1. the government buys back train assets from SMRT at 0.9-1.0x P/B,
2. SMRT pays down 50% of its outstanding debt, and
3. the remaining net cash gets fully paid out as a special dividend.
In our view, should a special dividend be paid, the theoretical price range for SMRT is S$1.43-1.48.

For the second consecutive quarter in 2QFY16, SMRT recorded an operating loss for its train operations and extended losses in its LRT business. The tough rail operating environment is likely to persist in the near term as repair and maintenance (R&M) works intensify due to the ageing rail system. We expect R&M expenses (+7.9% yoy) to outpace revenue growth (+6.3% yoy) in FY16. In addition, we expect FY16 capex to remain high at S$475m, mainly due to the upgrading of signaling and communication systems for the trains as well as for purchases of buses and taxis.

As SMRT has only about 25% (by bus fleet size) of Singapore’s bus market share, we think the group is a lesser beneficiary of the on-going bus restructuring. Evidently in the second bus package (Loyang) which received 10 bidders on 14 Aug 15, SMRT does not operate any of these bus routes or services.
In addition, with only 19% revenue contribution from the bus segment vs 50% from rail, we think the group will benefit more from the rail financing framework. Should SMRT’s bus operating margins expand from the current 2.4% to 8% (based on that of developed countries’ margins on a cost plus model), we estimate SMRT’s net profit to increase by S$3.1m in 2016.

Maintain HOLD and DCF-based target price of S$1.25, implying FY16 dividend yield of 2.7% and PE of 20.7x (WACC: 7.9%, terminal growth: 3.0%). We expect SMRT to rerate should there be any further details offering clarity on the railway restructuring.
However, we continue to like ComfortDelGro for its overseas growth potential, and geographical and earnings diversification.

Andrew Chow CFA UOB Kay Hian | Bennett Lee CAIA UOB Kay Hian | http://research.uobkayhian.com/ 2015-09-22

UOB Kay Hian Analyst Report HOLD Maintain HOLD 1.25 Same 1.25