ComfortDelGro - UOB Kay Hian 2016-07-01: No Brexit Woes For UK Business

COMFORTDELGRO CORPORATION LTD C52.SI

ComfortDelGro Corporation (CD SP) - No Brexit Woes For UK Business

We analysed the implication of Brexit on ComfortDelGro (CD)’s UK operations.
Given that the bulk of CD’s earnings stem from the more resilient bus segment, we have retained the view that downside impact is limited.
Additionally, our sensitivity analysis on a depreciating GBP showed marginal impact on net profit.
We continue to favour CD for its resilient outlook, strong cash flow generation and steady dividends.

We estimate that ComfortDelGro’s (CD) business in the UK accounts for approximately 25% of CD’s group revenue, and about 19% of operating profit, where we believe 88-90% of UK revenue and 97-98% of UK operating profit stems from its bus operations, with the rest from its taxi business.

We re-iterate the view that CD’s UK bus businesses face limited downside impact from Brexit. Metroline, which forms the bulk of the group’s UK bus business, operates under the London Bus Quality Incentive Contract (QIC) model, which is essentially similar to the Government Contracting Model in Singapore.
Under QIC, fare revenue is kept by the government, and the bus operator is paid to provide services and rewarded based on how reliable their bus services are. Given that operators do not bear fare revenue risk, ridership fluctuations will have limited impact.
Meanwhile, with freedom of movement and immigration being one of the main discussion points of the Brexit dialogue, concerns were raised regarding long-term impacts such as a shrinking labour force and wage increases. However, we believe wage inflation impact on UK bus operations is limited.
Under QIC, contract price is adjusted based on movements in cost base, including labour rates. Overall, we hold the view that UK bus margins will remain largely intact.

We note that CD’s UK taxi circuit business has been facing challenges since 2015, owing to reasons such as competition from disruptive technologies as well as declining private and public spending.
We believe the group’s taxi circuit business in UK will likely be further exacerbated by economy volatility following Brexit. However, considering that its taxi business only contributes 2-3% to UK operating profit, we believe that the change to overall earnings will be marginal.
As an indication, despite declining profits faced in the UK taxi circuit operations in 2015, overall UK operating profit continued to increase 3.5% yoy.

CD currently manages its forex exposure by matching revenue and costs in the relevant currencies to create a natural hedge for its operations overseas. We therefore reckon that the depreciation of GBP will mostly be translational in terms of conversion to SGD for reporting purpose.
Based on our sensitivity analysis, we estimate every 10% decline in GBP/SGD to have an approximate 2% change in net profit. Our current assumption is based on S$2/GBP.
With GBP/SGD cross rate at S$1.81 (at time of writing), that will impact our 2016 and 2017 earnings downwards by 1.9%, which in our view is not material.

We believe CD’s taxi business in Singapore remains resilient amid the inroad of private hire car operators, as we are of the view that the latter functions more as a substitute, such as for filling demand-supply gap during peak hours.
As an indication, we referenced the latest statistics from LTA, and tracked the average daily number of taxi trips from Jan 15 to Apr 16, the period in which we believe private hire car operators started to gain traction. Our analysis revealed that the average daily number of taxi trips for both one-shift (range: 18.6 to 20.9 trips) and two-shift taxis (range: 28.2 to 29.4 trips) remained largely unchanged during the aforementioned period.

Earnings maintained; steady 3-year EPS CAGR of 10.4%. No change in earnings estimate. The group continues to deliver and we forecast CD to register a healthy 3-year net profit CAGR of 10.4% over 2016-18F.
Key risks include weaker ridership or a lower-than-expected average fare increase in its bus and rail divisions. Other risks would come from third-party taxi apps having a negative impact on taxi revenue and difficulties in attracting younger taxi drivers, as well as higher-than-expected impact of Brexit on CD’s UK business.

Maintain BUY and DCF-based target price of S$3.16.
Against an uncertain macro outlook, we find CD resilient earnings and strong cash flows to be attractive defensive shields.
Pending the final terms of the bus financing framework, we foresee a potential for a special dividend of 5.6-6.2 S cents/share. This assumes that CD disposes its bus assets in Singapore at book value and pays out 50% of its net cash after the repayment of debt.

We see potential catalysts from:
- More accretive overseas acquisitions.
- Favourable terms for bus financing framework.
- Continued rise in dividends in 2016.

Andrew Chow CFA UOB Kay Hian | Thai Wei Ying UOB Kay Hian | http://research.uobkayhian.com/ 2016-07-01

UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 3.16 Same 3.16