SMRT - DBS Research 2016-07-18: Transit to stable but subdued profits

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SMRT CORPORATION LTD S53.SI 

SMRT - Transit to stable but subdued profits

• NRFF finally concluded and kicks in from 1 Oct 2016.
• SMRT will transit into asset light model; disposal of rail operating assets to LTA.
• Risks sharing mechanism limits SMRT’s profit volatility but also upside potential.
• Lowered FY17/18F earnings by 12%/28%; TP cut to S$1.28; Downgrade to FULLY VALUED.

New Rail Financing Framework to kick in from 1 Oct 2016. 

• The New Rail Financing Framework (NRFF) was announced. SMRT’s train operations will transit into an asset-light model with the disposal of assets to LTA for S$991m. 
• In turn, SMRT will pay a Licence Charge to the LTA. The LTA will also share revenue and profitability risks alongside SMRT. The licence period is also shortened to 15 years, from 30 years previously.

Trade off between earnings upside for sustainable and more stable profits. 

• The NRFF will relief SMRT of the heavy burden of future capex, estimated to be S$2.8bn. 
• There are, however, trade-offs. With the risks sharing mechanism, SMRT Trains is required to share profits through a tiered structure (of up to 95%) if EBIT margins exceed 5%. 
• On the other hand, LTA will share 50% of the shortfall in the event that EBIT margins fall below 3.5%. This provides less volatility to SMRT’s future earnings, though it will also limit the upside potential. 
• In addition, we note that risk sharing by LTA is limited to the Licence Charge to be paid by SMRT; LTA is not obliged to subsidise SMRT if operating costs exceed this amount, which would result in losses for SMRT.

Trim margins; FY17/18F earnings cut by 12% - 28% and TP to S$1.28; Downgrade to FULLY VALUED. 

• With the NRFF announcement, we revised our assumptions and cut FY17F/18F earnings by 12%/ 28% mainly on the more subdued margins for SMRT Trains (including rental). 
• Valuations look lofty at 26.9x/ 33.4x FY17F/ 18F PE. 
• We believe the market has priced in too much optimism on NRFF, and will be disappointed with the actual outcome. 
• While the NRFF provides sustainability to SMRT’s financial obligations, it is not a “sweet heart” deal. 
• Our TP is revised down to S$1.28, implying 22.3x/ 27.8x FY17F/ 18F earnings and dividend yield of 3.1%. Downgrade to Fully Valued.

Andy Sim CFA DBS Vickers | http://www.dbsvickers.com/ 2016-07-18

DBS Vickers SGX Stock Analyst Report FULLY VALUED Downgrade HOLD 1.28 Down 1.53