SMRT Corporation - UOB Kay Hian 2016-08-10: 1QFY17 Earnings Bogged Down By Rail Pains; Accept Offer

SMRT CORPORATION LTD S53.SI

SMRT Corporation (MRT SP) - 1QFY17: Earnings Bogged Down By Rail Pains; Accept Offer

1QFY17 results continue to be impacted by rail woes.
Meanwhile, even other major segments such as bus, taxi and rental business put up a poor showing.
We have trimmed FY17-18 net profit by up to 8% to reflect higher operating expenses on the back of heightened operational requirements and a more rigorous maintenance regime in the train sector.

We highly recommend investors to accept the offer price of S$1.68, which we believe provides a more palatable exit as fundamentals could deteriorate further.
Accept offer: S$1.68.

SMRT reported 1QFY17 net profit of S$15.5m (-23% yoy), which fell below our and street’s expectation. Earnings were impacted by lower top-line growth and higher operating expenses as most major segments performed poorly.
Group revenue decreased 2.0% yoy to S$313.9m in 1QFY17.
Meanwhile, operating expenses rose 0.8% yoy to S$311.5m, due mainly to higher staff costs and repair and maintenance costs, which were partially offset by lower energy expenditure and other operating expenses.

Rail business reported a higher operating loss of S$9.4.m in 1QFY17 compared with an operating loss of S$5.3m in 1QFY16. This was largely driven by higher loss in train operations as a result of lower revenue due to lower average fare resulting from 1.9% fare reduction effected in Dec 15 and cannibalisation impact by DTL2 operations, higher staff costs and repairs and maintenance related expenditure.
Meanwhile, rail maintenance expenses as a percentage of fare revenue increased to 49%, and is expected to range between 45-49% going forward.

1QFY17 operating profit from the group’s non-rail businesses decreased 12.3% yoy to S$29.0m, largely due to lower profitability in the bus (-86% yoy) and taxi segments (-18% yoy). Bus operations were impacted largely due to the 1.9% fare reduction as well as cannibalisation by DTL2.
Meanwhile, taxi operations suffered due to lower revenue from a smaller hired-out fleet as well as higher repairs and maintenance and depreciation.
We also understand that utilisation rate has decreased to 94% from 97% in the previous quarter.

Net gearing worsened to 67% in Jun 16, from 64% in March 16. Meanwhile, free cash flow remained negative at S$38m in 1QFY17.

Recall in July, Temasek and SMRT announced the proposed acquisition by Belford Investments (a wholly-owned subsidiary of Temasek Holdings) of all the issued ordinary shares in SMRT, by way of a scheme of arrangement where SMRT will be acquired by Belford for a cash consideration of S$1.68 per share.
A scheme document will be sent to investors in due course, and subject to regulatory and court approvals, SMRT expects to convene a scheme meeting by Sep/ Oct 16. Shareholder approval threshold stands at 75% in value of the scheme shares voted at the Scheme Meeting and a majority in number of shareholders present and voting at the Scheme Meeting. Temasek will not be eligible to vote on this occasion.

As SMRT transitions to the New Rail Financing Framework (NRFF), licence charges will be structured under a two-pronged mechanism (revenue shortfall sharing and profit sharing) to allow SMRT to achieve a composite of both fare and non-fare EBIT margin of 5%, with a collar set at 3.5%.
The profit sharing mechanism of NRFF limits the earnings upside of SMRT, where in the event of SMRT generating an EBIT margin in excess of 5%, LTA will share the upside of up to a maximum of 95% of incremental EBIT margin. Furthermore, it was emphasised by management that there will be no certainty the trains will earn an EBIT margin of 5%, considering risks relating to fare adjustments, operating expenditure increases, timing of asset renewal and regulatory changes.
As an indication, a scenario with a 10% increase in net operating expense will require a 5.5% increase in fare revenue to achieve a composite EBIT margin of 5%, which in our view, is no walk in the park.

Trimmed FY17-19 numbers down by 6-8% to reflect higher rail maintenance related expenses on the back of more rigorous maintenance regime in train operations in view of the ageing systems and more trains undergoing scheduled overhaul.

While NRFF will have a positive impact on future cash flow as well as gearing for SMRT, we believe the terms of the framework will cap much of the earnings upside for the Incumbent’s rail business.
We highly recommend investors to accept the offer price of S$1.68, which we believe provides a more palatable exit as fundamentals could deteriorate further.
Accept offer: S$1.68.

Thai Wei Ying UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | http://research.uobkayhian.com/ 2016-08-10

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