ComfortDelGro - CIMB Research 2016-07-20: Negative implications of SMRT's rail reform

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COMFORTDELGRO CORPORATION LTD C52.SI 

ComfortDelGro - Negative implications of SMRT’s rail reform

• The c.5% composite rail margin that the Land Transport Authority (LTA) granted to SMRT under the NRFF has led us to review our rail margin assumptions for CD.
• We cut FY16-18F EPS by 4-10% to reflect: 
  1. lower rail margins following the transition of CD’s NEL to the NRFF, 
  2. the weakened £ post-Brexit vote.
• We do not expect CD to be taken private by any party.
• We downgrade CD from Add to Hold, with a lower DCF-based target price of S$2.91 (WACC: 7.5%).

Negative surprise from SMRT’s rail reform

• SMRT, CD’s closest Singapore competitor, announced that it would reform its rail operation to the New Rail Financing Framework (NRFF) on 15 Jul. 
• While this reform was within expectations, the terms embedded in it were a big disappointment to the market. 
• According to the LTA, the licence charge under the NRFF has been structured to allow SMRT to achieve composite rail EBIT margin of c.5% (vs. 9-24% achieved under the old framework). This has prompted us to review our rail assumptions for CD.

CD’s current rail operations under old framework and NRFF

• Through its 75%-owned SBS Transit (SBS), CD currently operates two rail lines in Singapore: 
  1. the North-East Line (NEL), which started operations in 2003 under the old framework, and 
  2. the Downtown Line (DTL), which started in 2013 under the NRFF. 
• We note that although the NEL comes under the old rail framework, no rail fixed assets are carried by the SBS, as the NEL is still in the relatively early phase of operations (during which operating assets are sponsored by the LTA, according to the old framework).

Potential transition of SBS’s NEL to the NRFF

• According to its press release, the LTA is still in discussion with SBS on the possibility of the NEL transitioning to the NRFF. 
• We believe that the transition will take place, latest by mid-2017, in view of SBS’s possible capex burden of S$800m-1.2bn (US$590m- US$880m, based on our estimates) for the NEL under the old framework; this is compared to SBS’s limited equity base of S$349m (US$257m) as at 31 Mar 2016.

FY16-18 EPS cut by 4-10%

• We cut FY16-18F EPS by 4-10% to reflect: 
  1. lowered composite rail EBIT margin projections of 5% (vs. 9-19% previously), now in line with the LTA’s guided c.5% for SMRT under the NRFF, and 
  2. the c.10% depreciation of £ against S$ post-Brexit vote (the UK formed 20% of CD’s EBIT in FY15).

Possible offer for CD/SBS, similar to offer for SMRT?

1. We think there is low likelihood of CD being taken private by a major shareholder, as its biggest shareholder Blackrock has only a 6% stake in CD. 
2. We understand from CD’s management that the group does not have a plan to privatise SBS at this point. 
3. Possibility of privatisation of SBS by an external party (like government-linked Temasek making an offer to acquire CD’s 75% stake in SBS) is, at best, speculative, in our view.

Downgrade CD from Add to Hold, with lower target price of S$2.91

• With lower FY16-18 EPS forecasts, we downgrade CD from Add to Hold. We also lower our target price to S$2.91, based on CY16 DCF (WACC: 7.5%). 
• A key upside risk to our call is potential earnings-accretive acquisitions, while a downside risk is intensifying competition from Uber and Grab for its taxi business.

Roy CHEN CFA CIMB Securities | William TNG CFA CIMB Securities | http://research.itradecimb.com/ 2016-07-21

CIMB Securities SGX Stock Analyst Report HOLD Downgrade ADD 2.91 Down 3.27