ComfortDelGro (CD SP) - Maybank Kim Eng 2017-09-28: Back To Comfort Zone; Upgrade To BUY

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COMFORTDELGRO CORPORATION LTD C52.SI

ComfortDelGro (CD SP) - Back To Comfort Zone; Upgrade To BUY

Worst is in the price; catalysts from Uber & rail 

• We believe downside for its taxi operations has been largely priced in after ComfortDelGro's 12-month share price correction of 28%. 
• We cut EPS by 1-6%, to incorporate further taxi weakness and believe it is captured in our assumption of a 12-15% fleet size reduction pa. for FY17-19E. 
• Key catalysts:
  1. positive outcome from tie-up with Uber could reverse its taxi erosion;
  2. the opening of Downtown Line 3 in Oct 2017 could turnaround its rail segment; and
  3. Singapore bus should provide steady earnings, while FX weakness for UK bus should normalise in 2H17. 
• FY17- 19E dividend yields of > 5% are the highest since 2005, we think the yields are sustainable given ex-taxi FCF yield of 7.8% for FY18E. Our previous P/E methodology is inadequate, given structural disruptions to earnings.
• Our DCF-based Target Price is 9% higher, at SGD2.40, which implies 16.3x FY18E EPS (LT mean of 16.2x). Risks: slower rail turnaround and regulations.

Taxi’s relevance to fall; catalyst from Uber tie-up 

• ComfortDelGro’s potential tie-up with Uber, announced in Aug 2017, might mitigate its taxi business decline. The scenario of ComfortDelGro securing Uber’s car rental business and leveraging on Uber’s ride-booking platform should prove positive. 
• The Business Times reported that Uber has around 15,000 cars, similar to ComfortDelGro’s 15,000 cabs. This is close to Grab’s alliance of 25,000 rental cars and 10,000 non-ComfortDelGro cabs. 
• ComfortDelGro's reliance on taxis should decline significantly. This scenario is not yet in our earnings. We make deeper cuts and expect its taxi EBIT to fall 18%/12%/10% for FY17/18/19E vs 18%/5%/4% previously.

Rail turnaround and bus segment to fill taxi gap 

• Its rail segment should turn around after the opening of Downtown Line 3 in Oct 2017, which should double ridership. Rail EBIT loss of SGD25m for FY17 should turn around to +SGD5m and +SGD27m for FY18E and FY19E.
• Taxi’s EBIT contribution to the group should decline to 26% in FY18E from 35% in FY16, as bus and rail increase to 51% from 37%. 
• Singapore bus should provide steady fees under a new contract model with uplift from the new Seletar Bus Package kicking in in 1Q18 and better UK bus as the forex impact of Brexit normalises. We expect the bus EBIT to grow 24%/4%/-4% for FY17/18/19E, assuming it loses a bus contract due 4Q18.

Comfortable entry level 

• ComfortDelGro’s forward dividend yield of > 5% is the highest since 2005; it touched 5% only during the 2008 financial crisis. 
• In addition, its forward P/E of 13.6x is 1SD below its 13-year mean. 

Robust FCF could sustain dividends even without taxis 

• ComfortDelGro has consistently generated healthy operating and free cash flow. Since 2007, it has generated operating cash flow of around SGD600-800m and FCF of SGD200-400m each year, excluding acquisitions. 
• In addition, its capex has started to decline since 2015, due to:
  1. its transition to an asset-light business for its Singapore bus since Sep 2016;
  2. a reduction of its Singapore taxi fleet size; and
  3. a longer renewal period of its Singapore taxis due to a more challenging environment.
• Excluding taxi’s cash flow, we estimate that ComfortDelGro’s FY18 FCF will only decline by SGD120m (SGD320m taxi EBITDA minus SGD200m capex savings from taxi fleet renewal of 2,500 vehicles pa) to SGD335m. Its FY18E FCF yield will fall to 7.8% from 10.6%. In this scenario, ComfortDelGro should still have ample headroom to maintain 5% dividend yields, by funding a > SGD10cts DPS or > SGD215m cash dividend payouts every year.

Healthy balance sheet with net cash as bonus 

• In addition to its robust cash flow, ComfortDelGro has a healthy balance sheet with SGD230m net cash as of 2Q17. Combined with its total equity base of more than SGD3b, we estimate it could simply gear up and take on SGD1b of debt for local or overseas expansion, if such opportunities arise.

Downtown Line 3 to turn around its rail segment 

• When Downtown Line 3 (DTL3) opens on 21 Oct 2017, it will mark the completion of the entire DTL. The entire line will be 42km long. The 21km long DTL3 has 16 stations and it’s the longest stretch of Downtown Line to be opened. It will facilitate travel from eastern Singapore to the Central Business District. 
• Since the opening of DTL1 in Dec 2013, ComfortDelGro’s rail segment has been barely profitable, it ran into deeper losses in FY17, due to preparation costs for the opening of DTL3. Management expects this line to break even in 2H18 as daily ridership is expected to double to c.500k/day, based on Land Transport Authority’s projection. 
• We expect the rail segment’s EBIT loss of SGD25m for FY17 to turn around to +SGD5m and +SGD27m for FY18E and FY19E.

Singapore bus to fare well under a new model 

• Singapore bus segment has recorded notable improvements since a new bus contracting model was implemented in 4Q16. This was reflected under its subsidiary, SBS Transit (SBUS SP; NOT RATED).

Growing demand for bus and rail services in Singapore 

• Historical ridership data show that bus and rail are becoming more popular form of public transport. Unlike previously, growth in public transport ridership has in recent years been driven more by the local population. In 2016, bus and rail ridership rose by 4.3% YoY to hit a daily average of 7.2m - a new record and the 12th consecutive annual rise since 2005. The MRT followed with a 7.5% increase to 3.1m rides a day.
• Buses remain the dominant mode; they posted a 1.2% increase to 3.9m rides a day. NUS transport researcher Lee Der Horng attributed the growth to the "multiplier effect" of new MRT lines. This means that a new line would attract riders beyond those who live or works in its immediate vicinity. The DTL, opened in Dec 2015, may have played a role.
• Meanwhile, taxis posted a 5.5% drop in ridership, likely because of the popularity of private-hire options.

UK bus segment to normalise post-Brexit shock 

• The UK bus segment has suffered from a forex impact in the past four quarters, since the announcement of Brexit in Jun 2016. This should normalise as 2H17 will be compared YoY to a period with a much weaker GBP against SGD. 
• In 2Q17, revenue fell SGD24m, of which SGD18m came from forex losses. UK is ComfortDelGro’s largest overseas market, it contributes c.15% to ComfortDelGro’s EBIT in 2Q17.

Positive scenario of a potential tie-up with Uber 

• In Aug 2017, ComfortDelGro announced it was in exclusive discussion with Uber to form a potential strategic alliance on:
  1. the management of Uber's fleet of vehicles; and
  2. booking software solutions in Singapore, including ComfortDelGro’s taxis. 
• Following regulatory issues faced by Uber in several countries, such as a recent withdrawal of its operating licence in London, it might be more open to this tie-up. We expect further developments by end-2017. Two positive scenarios include:
  1. ComfortDelGro getting the private car rental business and is allowed to charge a profitable rate; and
  2. surge pricing service for ComfortDelGro on Uber’s platform, which could level the playing field with their competitors.
• For the management of Uber’s vehicles, repair and maintenance are the low hanging fruits and will not contribute much. The positive scenario will be where ComfortDelGro gets the car rental business. Currently, Uber owns Lion City Rental, which provides car rental services to its drivers. The Business Times reported that Uber’s rental company has around 15,000 cars, similar to ComfortDelGro’s 15,000 cabs. This is close to Grab’s alliance of 25,000 rental cars and 10,000 non-ComfortDelGro cabs.
• Another positive scenario is surge pricing service for ComfortDelGro, which is a competitive edge for private hires, due to more competitive pricing than taxis most of the time. To recap, Grab made its surge pricing service exclusive to all Singapore taxis in Mar 2017, except for ComfortDelGro. ComfortDelGro reacted shortly with a fixed fare scheme, which has not helped much.
• The key earnings contributor to ComfortDelGro’s taxi business is rental income (utilisation rate x fleet size) and its tie-up with Uber could potentially help to improve its utilisation rate. Booking revenue and cashless transaction revenue are just small contributors. Also, Uber could share revenue of ComfortDelGro’s Taxi booked under its platform. Grab claims that it has a 95% market share in 3rd party taxi hailing and a 72% market share in private-vehicle hailing in ASEAN.

Intensifying competition in Taxi segment 

• Grab has launched an aggressive promotion to entice ComfortDelGro’s taxi drivers into its fold since late Aug 2017. This campaign started shortly after ComfortDelGro announced its potential exclusive tie-up with Uber and Grab’s success in securing funding of USD2.5b.
• LTA data show that the number of taxis continues to shrink while the number of rental vehicles accelerates. Grab remains tenacious in its pursuit to expand its already dominant position in ASEAN by undercutting its competitors. It is aiming for more than just private hire services.
• We expect ComfortDelGro’s taxi segment to fare poorly over the next three years, especially for FY17 and FY18, due to greater competition. Data from the Land Transport Authority show that ComfortDelGro’s taxis are declining at a quicker pace, at 8.9% YoY in Jun 2017. Based on this, we expect ComfortDelGro’s fleet size to decline 12-15% for FY17-19E. Accordingly, we make deeper cuts and expect the taxi segment’s EBIT to fall 18%/12%/10% for FY17/18/19E, from 18%/5%/4% previously.

Sensitivity analysis for taxi segment 

• Our sensitivity analysis shows that every 10% decline in taxi EBIT could reduce ComfortDelGro’s EBIT by 2-3%. In the worst-case scenario where taxi EBIT falls to zero, our FY18E EPS could fall by 30%.
• Assuming taxi EBIT declines by 50% each year from FY17E, ComfortDelGro will trade at 17x FY18E P/E and FY19E EPS. This will be slightly above its 13-year P/E mean of 16x. Under this scenario, its taxi EBIT will fall to nearly zero in FY19E.

DCF valuation to better capture FCF strength 

• Against unprecedented disruptions to ComfortDelGro’s business model, our previous Target Price based on its historical P/E is inadequate. We switch our valuation methodology to DCF, to better capture imminent weakness in taxis while recognising ComfortDelGro’s cash generative operations. Our DCF-TP of SGD2.40 implies 16.3x FY18E EPS, this is on par with ComfortDelGro’s long term mean of 16.2x. We ascribe a beta of 1.0, a 20% premium to ComfortDelGro’s beta of 0.82, to account for greater near-term profit volatility, for its disrupted taxi segment.
• We also see investors in ComfortDelGro becoming more yield-centric. Since ComfortDelGro recent share-price correction in response to intensifying taxi competition and unsuccessful bid for the Thomson East Coast Line, FY17-19E dividend yields of > 5% are the highest since 2005. More importantly, we assess yields to be sustainable given ex-taxi FCF yields of 7.8% for FY18E.

Summary financials of key segments 

• Key changes made are deeper cuts for its taxi segment; we now expect taxi EBIT to fall 18%/18%/14% for FY17E/18E/19E, from 18%/12%/10% previously. Accordingly, our EPS is reduced by 1%/4%/6%.

John Cheong CFA Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2017-09-28

Maybank Kim Eng SGX Stock Analyst Report BUY Upgrade HOLD 2.40 Up 2.250