Singapore Land Transport - RHB Invest 2016-08-12: Final Pieces In Place For Bus GCM Implementation

COMFORTDELGRO CORPORATION LTD S52.SI SMRT CORPORATION LTD S53.SI

Singapore Land Transport - Final Pieces In Place For Bus GCM Implementation

SBS Transit and SMRT have finalised their contracts with the LTA to operate bus services for tenures between 2-10 years under the GCM from September.
SBS Transit will receive SGD5.3bn in fees to run 196 bus services while SMRT will get SGD1.9bn in fees to operate 77 bus services.

Bus asset sales will be undertaken at book value and the LTA will pay the cash over the remaining life of the bus assets.
ComfortDelGro and SMRT should see their bus EBIT margins enhanced to a more sustainable 7.5% under the GCM from current operating losses.
Maintain OVERWEIGHT.

In comparison to the 5-year contracts offered to Tower Transit Singapore and the Go-Ahead group, incumbent operators have managed to negotiate 2-10 year contract tenures for different bus packages. The average contract tenure for SBS Transit is seven years while SMRT Corp (SMRT) (MRT SP, NEUTRAL, TP: SGD1.68) is six years.

Instead of an outright purchase of about 4,000 buses – which are currently owned by the incumbent operators – the Land Transport Authority (LTA) will lease the buses from the operators by paying a fee that is equivalent to the depreciation value of the buses. The implied financial cost of these buses to the LTA will be the same as buying over the buses at net book value.
While this is better than our expectation of a sale of buses at a 10% discount to book value, the cash received by the operators from the transfer of bus ownership will now be spread over a longer contract period instead of five equal instalments.

For 1QFY17 (Mar), SMRT reported a SGD200,000 operating profit for its bus business, implying an operating margin of 0.3%. Its bus business has been reporting operating losses for seven of the last eight financial years (FY09-15).
SBS Transit reported SGD9.4m in operating profit for its bus business in 2Q16 (+26% YoY), implying an operating margin of 4.6%.
We expect both SMRT and SBS Transit to earn 7.5% operating margins post transition to bus the Government Contracting Model (GCM) starting 1 Sep.

The contract fee payable by the LTA to incumbent operators excludes adjustments for inflation, changes in wage level and fuel cost, service variation, and incentive payments.
While the operators could be penalised for not meeting services standards, likely upwards adjustments for wage inflation and sudden rises in fuel costs does ensure that operating margins remain sustainable over the contract period.
We remain optimistic about our operating margin estimates, as the operators will also be allowed to retain the advertising and rental revenue generated from their bus operations.

For 2Q16, CD’s subsidiary involved in vehicle inspection services in Singapore – VICOM – booked a SGD6.6m profit (-13% YoY).
SBS Transit, another of CD’s subsidiaries that operates local bus and train services, reported a profit of SGD7.2m (+19% YoY).
Using the weakness in hire out rates reported by SMRT for its taxi business in 1QFY17, we expect CD’s Singapore taxi business to witness some pressure in margins (adjusted for taxi driver benefits).

We are reviewing our estimates for CD and SMRT, as we await details on the asset value and age profile of the bus assets that are owned by the two incumbent bus operators.
We continue to like CD for its more visible earnings growth amidst an uncertain economic environment, diversified earnings base, and strong net cash balance sheet.

Shekhar Jaiswal RHB Research | http://www.rhbinvest.com.sg/ 2016-08-12

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