ComfortDelGro Corporation (CD SP) - UOB Kay Hian 2016-11-24: Strengths On Many Fronts Except Share Price

COMFORTDELGRO CORPORATION LTD C52.SI

ComfortDelGro Corporation (CD SP) - Strengths On Many Fronts Except Share Price

Despite resilient 3Q16 results, ComfortDelGro Corporation (CD) trades at an undemanding 15x 2017F PE, 9% below its 10-year historical PE average. We believe the discount is not justified, given CD’s strong fundamentals and cash generation capability.
There is dividend payout upside on its transition to an asset-light model as well as M&A opportunities, which may be potential share price catalysts.

Share price of ComfortDelGro Corporation (CD) has retraced 21% from ytd high and now trades at an undemanding 15x 2017F PE, 9% lower than its 10-year mean of 16.4x. We think the discount is not justified, given its 2016-18F ROE of 13.4-13.8% are higher than its long-term mean of 12.6%. Also, CD has a stronger cash flow generation capability now, with net cash of S$259m as at Sep 16 (S$0.12/share) compared with a net debt position in 2007.
Given strong financials, we see potential M&A opportunities, likely within the group’s operating geographies and segments.
Barring any major M&A, we also see dividend payout upside on lower capex upon its transition to an asset-light model.
We see recent share price pullback as an attractive entry opportunity.

Despite unfavourable industry indicators such as a growing private rental fleet and declining average mileage for taxi drivers, CD continues to surprise on the upside, with a 4ppt yoy rise in taxi operating margin in 9M16.
Impact of private hire car on taxi may be gradual than steep. While the taxi industry remains challenging, we believe any impact on CD will likely be gradual than steep.
Notably, despite a near doubling of private hire car drivers in the past year, CD’s hire-out rate remained resilient at 99%, which suggests that the industry may not be zero-sum.
Moreover, CD tends to attract a different driver demographic catering more to full time drivers looking for stable income, while private hire car operators (characterised by high churn rate) attract drivers who look for flexibility in schedule. In the next 1-2 years, we believe taxi earnings will continue to be supported by higher rental income from fleet renewal as well as high utilisation rate.

While its UK bus revenue has been affected by unfavourable translation from the weaker pound, this segment remains operationally strong. Based on our estimates, the business historically garnered EBIT margins of 8- 10% and even reached about 11% in the past two quarters.
Understandably, the budget cut on the Transport For London may result in a more competitive contract bidding environment for UK bus operators in the longer term. However, we believe margins could be sustained through cost efficiency and earnings underpinned by more contract wins on the back of an expanding London network.

CD transitioned to the new government contracting model (GCM) on 1 Sep 16, where the group will be paid a contract fee estimated to be worth S$5.32b for seven years. The contract fee will cover the service fee for the provision of bus services (ie the cost to operate the services as well as an agreed operating margin), and leasing fees based on depreciation of the buses over the statutory lifespan.
Under the bus contracting model, we estimate CD’s Singapore bus segment to generate EBIT margins of 8-9% from 4Q16, up from its historical margins of 1-3% in 2014-15 and 4.5% in 3Q16.

We estimate rail margins to remain depressed at 1-3% in 2016-17 on start-up costs ramping up for the new Downtown Line (DTL) as well as the 4.2% fare reduction from 30 Dec 16.
Nevertheless, with DTL3 slated to open in Sep 17, we believe ridership growth will gain momentum via the network effect, contributing to a margin recovery for rail in 2018.
Following the opening of DTL3, CD may also transit to the New Rail Financing Framework (NRFF) for NEL. We continue to hold the view that NRFF for NEL may not be as onerous as for SMRT, due to differing earnings history as well as the lifecycle of lines for the two incumbents.

Earnings forecasts maintained; steady 3-year EPS CAGR of 6%.
No change to our earnings estimates. We forecast CD to register a healthy 3-year net profit CAGR of 6.0% over 2016-18F.

Maintain BUY and PE-based target price of S$2.90, based on 17.9x 2017F PE, which is a 10% premium to its 10-year mean PE.
We continue to like CD for its defensive qualities, strong cash flow and a diversified earnings stream.
We also see potential catalysts from rising dividend payouts or accretive M&A.

We see potential catalysts from:
1. More accretive overseas acquisitions.
2. Rising dividend payout.

Andrew Chow CFA UOB Kay Hian | Thai Wei Ying UOB Kay Hian | http://research.uobkayhian.com/ 2016-11-24

UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 2.900 Same 2.900