Land Transport Sector - OCBC Investment 2016-08-18: SEASON OF CHANGES


Land Transport Sector - SEASON OF CHANGES

  • Bus GCM details finalised.
  • New rail framework.
  • Temasek to buyout SMRT.

A year of many regulatory changes.

  • With just a few months left to the year, 2016 has been an eventful one across the land transport sector. 
  • Firstly, we saw the introduction of new regulations for the private hire car service industry back in Apr 16, with a focus on ensuring safety for commuters. LTA also partially loosened the existing taxi driver’s training and license criteria. Nonetheless, our view remains unchanged as we still see disparity relating to applicable standards and pricing structures between traditional taxi business and private hire car services, and do not rule out the possibility that LTA may further loosen the strict taxi standards to level playing field. 
  • Secondly, LTA announced on 15 Jul the finalized new rail financing framework (NRFF), which SMRT Corporation’s (SMRT) rail network will transit to from 1 Oct onwards. As previously stated, we think the NRFF may not be a good deal for SMRT over the longer-term given that its composite EBIT margin (fare and non-fare) upside in excess of 5% will be limited through profit sharing with LTA. Days after on 20 Jul, Temasek offered to acquire all remaining shares of SMRT that it does not already own for S$1.68/share in cash through a scheme of arrangement. 
  • Finally and most recently on 11 Aug, contracts of the new bus government contracting model (GCM) for the incumbents were finalized and will be effective from 1 Sep.

Mixed 2QCY16 results from SMRT and CDG

  • 2QCY16 results of both Public Transport Operators (PTOS), ComfortDelGro Corporation (CDG) and SMRT, came in mixed, partly impacted by the 1.9% fare reduction in Singapore. 
  • For CDG, 2Q16 was within expectations, with revenue driven by its rail and taxi segments but partly offset by impact from unfavourable currency translation effect (mainly due to weaker GBP against SGD). Despite much concern about private hire car services, its taxi business remains resilient with hired-out rate still close to 100%. We also expect DTL2 to be a key revenue driver, but unlikely to breakeven until after DTL3 starts in CY17. 
  • For SMRT, 2QCY16 (or 1QFY17) earnings came in below expectations on worsening profitability. Revenue declined for both core rail and bus operations while operating expenses continued to increase due to higher staff costs and repair and maintenance costs. Rail maintenance-related expenses (MRE) formed 49% of rail revenue, which eroded earnings as core rail operating loss widened. We expect fare reduction, cannibalization impact from DTL as well as high MRE to continue to drag CY16 and CY17 earnings. 
  • For both PTOs, we expect them to continue to benefit from lower energy costs for CY16.

Maintain NEUTRAL

  • With many regulatory changes still in progress, and given that there is still the risk that the proposed buyout of SMRT [ACCEPT THE OFFER; FV: S$1.40] by Temasek falling through, we maintain our NEUTRAL rating on the land transport sector for now, as we await for better clarity. 
  • Our top pick within the sector is CDG [BUY; FV: S$3.21], given its diversified revenue base, resilient taxi earnings and improved free cash flow outlook post-GCM.

Eugene Chua OCBC Securities | http://www.ocbcresearch.com/ 2016-08-18
OCBC Securities SGX Stock Analyst Report BUY Maintain BUY 3.21 Same 3.21
ACCEPT OFFER Maintain ACCEPT OFFER 1.40 Same 1.40