SMRT - Maybank Kim Eng 2016-07-18: Sharp margin decline in the new regime

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SMRT CORPORATION LTD S53.SI 

SMRT(MRT SP) - Sharp margin decline in the new regime

Stretched valuations against revised EPS; D/G SELL

• The long-awaited transition to a New Rail Financing Framework (NRFF) had been announced. Rail asset sales will bring a marked improvement to SMRT’s balance sheet and relieve it of large capex obligations. 
• However, its rail business will suffer from structurally lower profitability under the new regime. We cut FY17-19 EPS by 19-39% for this. 
• We believe the sharp decline in profitability is a key source of variance from street view and expect earnings downgrades. We switch to a DCF-based valuation (from PER model) for better cashflow visibility under the new regime and lower our TP to SGD1.36 (from SGD1.40). 
• At 30x FY3/18E P/E and dividend yield of just 3%, valuations are stretched for a utility stock with limited growth prospects. 
• D/G to SELL from HOLD.

No special DPS from asset sale...

• The Land Transport Authority (LTA) will purchase almost SGD1b of assets held by the operator and relieve it of capex obligations of around SGD2.8b. This will bring significant improvement to its balance sheet. 
• Management will reduce debt with the proceeds, pay off relevant taxes and reinvest to improve its competencies. It has explicitly stated that it does not intend to pay a special dividend. This could be a source of disappointment.

...structural decline in rail profitability

• In exchange for the asset sale and capex relief, profitability for SMRT’s rail business will fall significantly from a five-year average of 16% EBIT margin to only 5%. This will bring a structural decline in its profitability and we expect significant earnings downgrades on this.

Deal structure limits profit upside for shareholders

• While the LTA will assume part of the revenue and profitability risk in the new regime, the deal is structured in the regulator’s favour. It will retain a lion’s share of any margin upside beyond 5%, but take a smaller share of the downside below 3.5%. 
• Proforma analysis disclosed by SMRT showed that a 10% rise in expenses will result in a 3ppt cut in its margin, but a similar 10% decline in expenses will lead to only a 0.4ppt increase in profitability. This essentially limits profit upside for shareholders.

Derrick Heng CFA Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2016-07-18

Maybank Kim Eng SGX Stock Analyst Report SELL Downgrade HOLD 1.36 Down 1.40