ComfortDelGro - Maybank Kim Eng 2020-05-17: Comfort In The Unknowns

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COMFORTDELGRO CORPORATION LTD (SGX:C52)

ComfortDelGro - Comfort In The Unknowns

Initiate coverage with BUY; Defensive long term

• Reinitiate coverage of ComfortDelGro with BUY and DCF-based Target Price of SGD1.99 (WACC: 8.2%, LTG: 1%).
• 63% of ComfortDelGro’s revenues are secured by contracts. Hence, every one month extension of the lockdown in Singapore will reduce PAT by just 0.3%, we estimate.
• Our FY20/21E dividend payout assumptions of 60% are conservative (vs. 73% 5-year average) and offers 3.3% yield (a 220bps spread over 10-year SG bonds). FY19 dividend payout ratio of 80% would imply a 4.4% yield. See ComfortDelGro Dividend History.
• The pandemic notwithstanding, we believe longer-term public policy and ESG preferences will favour public transport. Together with a strong track record of accretive M&A in overseas markets, ComfortDelGro offers significant exposure to this long-term structural theme.

ComfortDelGro - Corporate Information

• ComfortDelGro (SGX:C52) is one of the world’s largest land-transport conglomerates with a fleet of 41,600 vehicles as at end-2019, covering businesses such as public buses, railway, taxis, automotive engineering, vehicle inspection and driving centres across Singapore, Australia, the UK, China, Vietnam and Malaysia.

Public transport: Largest defensive contributor

• Under public-transport services are its bus and railway businesses, with the bus business contributing 85% of its total revenue for this segment. The proportion of bus revenue may continue to increase as ComfortDelGro makes further overseas expansions.
• In Singapore, its 75%-owned SBS Transit (SGX:S61) has a leading 60+% market share of scheduled bus routes with 3,400 buses. ComfortDelGro also operates four major rail systems through SBS Transit:
  1. North East Line (NEL) with 16 stations covering 20km;
  2. Punggol Light Rail Transit (LRT) with 14 stations;
  3. Sengkang LRT with 15 stations; and
  4. Downtown Line (DTL) with 34 stations spanning 42km.
• Singapore’s bus-operating business was converted to the BCM model in Sep 2016. Under BCM, SBS Transit operates nine bus packages of routes with an average contract period of seven years. Bus assets are now owned by the government. Fare revenue collected is retained by LTA and service fees are regulated based on changes in wage levels, inflation and fuel cost. Under this BCM framework, bus profitability and cash flows have improved over the years. Also, cashflow is less volatile as it’s not affected by changes in ridership numbers while capex is the responsibility of the government.
• Meanwhile, ComfortDelGro invested SGD479m in 2018, primarily in Australia’s bus industry, which operates under a similar BCM framework. This should further improve the defensiveness of ComfortDelGro’s cashflow.
• On the other hand, railway operations do not fall under BCM framework and are susceptible to volatility in fares and ridership. Its DTL operations have been suffering from LTA’s lower than expected average daily ridership of 500,000 (and 700,000 gradually over time).
• That said, the recent new Thomson East Line (TEL) was tendered out under BCM to rival SMRT. Future rail line operations that ComfortDelGro potentially bids for may also be subject to BCM’s defensive earnings framework.

Taxi services: drivers back in market; PHC shifting its battle elsewhere

• ComfortDelGro is Singapore’s largest taxi operator. Its Comfort and CityCab brands operate over 10,700 taxis as at end-2019, translating to 58% fleet market share, far ahead of the second and third largest players with 16% and 13% market share respectively. ComfortDelGro purchases vehicles and rents them out to self-employed taxi drivers.
• Competition was intense in 2016 with the rise of ride-hailing players like Uber and Grab, resulting in total fleet numbers in the industry declining by 8% CAGR over 2015-2019.
• That said, indicative of the industry attrition was the number of taxi driver vocational licences (TDVL), which fell in 2017, but gradually recovered in 2018 and 2019 at a CAGR of 2%. This suggests taxi drivers are returning to the market.
• Indonesia-based ride-hailing Gojek has entered Singapore since Jan 2019, presenting new risks to the taxi industry. However, ride-hailing players like Grab and Gojek have been reducing their emphasis on price competition and shifting their focus towards services beyond transport, such as food delivery, digital payments, logistics and business-partner solutions.

Higher-margin support services

• ComfortDelGro offers services that support its core land-transport businesses. It includes automotive engineering, vehicle inspection (Vicom (SGX:V01)), car-rental and bus-station operations. These services made up 9% of ComfortDelGro’s 2019 revenue.
• However, the segment contributed a much higher EBIT margin of 24% than the rest of the segments. That said it is unlikely that the support services will grow going forward.
• ComfortDelGro's overseas expansion: contributing bigger pie
• ComfortDelGro began its overseas expansion soon after its listing in 2003. Since then, the UK, Ireland and Australia have become its largest revenue and EBIT contributors outside of Singapore. 2018 marked one of its biggest acquisition years, with management executing SGD479m of purchases, mostly to tap bus opportunities operating under a BCM-like model in Australia. Management continues to evaluate investments in developed countries that operate under contracting models.
• EBIT margin is mainly driven by businesses in Singapore and Australia as they contributed 66% and 19% of FY19 EBIT. Going forward, EBIT margin should remain stable as ComfortDelGro continues to grow its BCM-like businesses overseas.

ComfortDelGro's Public Transport Business: Bigger and Stronger Earnings Base

63% of revenues are stable and dependable

• The complete transition to the bus-contracting model (BCM) scheme in Singapore since 2016 represents the bedrock of ComfortDelGro’s earnings. In 2019, we estimate this accounted for 46% of total EBIT. The BCM scheme removes risks from fluctuation in ridership numbers.
• Under BCM, the Land Transport Authority (LTA) will determine the bus services and service standards to be provided, and bus operators will bid for the right to operate these services. In return, they will be paid fixed fees and incentives upon meeting standards set by the LTA, while fare revenue will be retained by the government.
• As part of the new bus industry model, the government owns all bus infrastructure such as depots, as well as operating assets such as buses and fleet management system.
• The public transport segment’s contribution to total revenue has grown from 57% in 2016 to 74% in 2019. Within this segment, ~85% of FY19 revenue was from the BCM scheme, while the remaining 15% was from its Singapore railway business.

Train prospects brighter in the long term

• The Singapore railway business remains the main drag in the public transport segment. This is mainly because Downtown-Line (DTL) ridership has been lower than what LTA forecasted. But the gap between forecast and actual ridership has been closing rapidly in the past two years. Covid-19 circuit breakers will reverse this trajectory in 2020E, but structurally ridership gaps should dissipate in a normalised operating environment as riders start adopting DTL as their preferred route.
• Going forward, railway revenue should improve and EBIT loss from the railway business should narrow as operating leverage improves.
• The upcoming Thomson East Line (TEL) is already tendered to SMRT under the government contracting model, similar to the bus contracting framework to reduce revenue uncertainty for the operator due the complexity of the project (station interchanges linked to other MRT lines).
• SMRT’s (almost a pure railway operator) is experiencing losses due to falling revenues and rising operating costs. The existing railway revenue model is unlikely to be sustainable if the government wants increased participation of private operators in future railway projects. As a result, we expect future railway contracts may adopt the BCM framework to provide better operating visibility for private players.
• This would be a catalyst for ComfortDelGro as it will bid for new railway projects, and it should further reduce group revenue volatility.

Stable, overseas revenue contributions set to overtake domestic revenue by 2023E

• ComfortDelGro has been increasingly investing overseas to supplement its Singapore earnings base. Overseas revenues have increased from 26% of total revenue in 2003 to 42% in 2019. A primary focus of overseas acquisitions has been ensuring revenue stability. 42% of its acquisitions since 2014 have BCM-like revenue schemes in place, especially in its major markets such as Australia. According to management, ComfortDelGro is constantly on the lookout for earnings-accretive deals in developed countries where the government is supportive of public transport and operates on BCM-like schemes.
• Possible acquisition targets include those in Australia and the UK, where ComfortDelGro continues to establish a stronger foothold, as well as new markets such as the Middle East and Continental Europe.
• Progressively, we expect overseas revenues to make up the majority of ComfortDelGro’s revenue in the long run. By 2023E, we estimate overseas revenues may overtake domestic revenues for the first time.

ComfortDelGro's Taxi Business: Rental rebates to impact earnings this year; but industry shows signs of stabilisation pre-COVID-19 outbreak

Pandemic Impact: a known, unknown

• Taxi contributed only 17% of total revenues in 2019. Taxi ridership has fallen off a cliff as the pandemic has progressed. It has been further impacted by Singapore’s circuit breakers as all non-essential businesses and services are closed until 1 June. As a response to this, ComfortDelGro has provided several rounds of rental rebates for taxi drivers amid increasingly stricter social distancing rules implemented by the government. The rental rebates are likely to amount to ~SGD115m if fully implemented. ComfortDelGro has provided full rental waivers to taxi drivers from Apr to Jun amid the circuit breaker. This will have a significant downside impact to the earnings of the taxi segment.
• Our base case assumes circuit breakers continuing until 1 June, which may result in taxi revenue contribution declining to 14% of total revenue in FY20E vs an average of 25% for the past five years.
• We acknowledge the situation is fluid and the lockdown could be extended. Our sensitivity analysis shows that a further one-month extension would lower EPS by just 0.3%.
• That said, upside catalyst would come from lifting of social distancing measures and the subsequent recovery of the taxi business. During SARS, we note that taxi drivers’ average net income returned to SGD66 (from SGD46/ day) one week after Singapore was removed from the WHO’s list of SARS-affected countries.

More rational competition?

• Before the Covid-19 outbreak, the taxi industry was showing early signs of stabilisation. Competition amongst taxis and private hire car (PHC) players had been rationalising since the peak of competition in 2016, helped by the merger of Grab-Uber in early 2018.
• But incentives for both ride-hailing drivers and passengers have been decreasing over the years since 2016, despite the recent entry of Indonesian superapp Gojek.
• This is because PHCs have been shifting their focus to other non-transportation businesses to improve profitability. Grab aims to become a one-stop, on-demand services provider within the region with its latest USD850m raised.
• Grab recently launched several business verticals and it’s now placing more emphasis on its expansion into financial services across Southeast Asia. The company is also looking to co-develop financial products and solutions with strategic investors.
• Most importantly, ComfortDelGro’s taxi fleet had contracted at a slower pace since the Grab-Uber merger in 2018. ComfortDelGro’s fleet size grew for the first time in Jan 2020 since 2014.
• Additionally, we think that the private-hire players are looking at survival and prolonging cash burn at this point in the Covid-19 outbreak, rather than growth.

ComfortDelGro - Still a dividend play

• Media reports have increased on companies across markets that have recently slashed or cancelled dividends as a liquidity preservation tool. Given the impact of slowing ridership for both railway and taxis, there are significant fears that ComfortDelGro may also follow a similar path.
• However, the majority of companies that have cancelled dividends have high gearing levels, negative free cash flow and/or are recipients of government bailouts. For ComfortDelGro, we note its FCF yield on average has been 170bps above the dividend yield. As a result, we believe scenarios where dividends are cancelled, or no dividends are paid have lower relative probability.
• For 2020E, we conservatively estimate the payout ratio to fall 20ppts to 60% and remain at this level for 2021E. This implies a FY20/21E dividend yield of 3.3% and 4.6%.
• Even at this lower payout ratio, the dividend yield spread between the 10- year Singapore government bond and ComfortDelGro’s yield is in line with the historical average of 2%.
• ComfortDelGro's share price weakness can be attributed to the escalation of Covid- 19 outbreak and increasingly stringent social distancing rules. The stock has fallen 39% YTD.
• During SARS, it took 9-10 months for ComfortDelGro's share price to recover and it surged 75% thereafter. Similarly during GFC, it took eight months for the stock to recover 43% from its trough.
• ComfortDelGro's current share price is supported by FY20E dividend yield of 3.3%. Singapore’s lockdown and social distancing measures are starting to contribute to the flattening of the Covid-19 new infection curve. Since the peak in April, daily new infections have fallen 53%. See ComfortDelGro Dividend History.

ESG preference for public transport to benefit ComfortDelGro

• Governments in developed countries have been pushing for the use of public transport and electric vehicles to reduce traffic congestion and environmental impact.
• For instance, Singapore in 2018 implemented the zero-vehicle-growth policy by freezing the number of private cars and motorcycles on its roads. The government is tightening the new COE (Certificate of Entitlement or the right to vehicle ownership for a period of 10 years) scheme, and quota is falling in line with replacement of de-registered cars.
• Singapore will further push towards its car-lite goal with the impending implementation of satellite-based Electronic Road Pricing (ERP). The new system will charge according to the distance covered on each trip, rather than the present system that only charges when travelling under gantries positioned at bottleneck zones.
• Meanwhile to support its 2040 Land Transport Master Plan where door-to-door journeys in city and neighbourhoods can be done in 45mins and 20mins respectively, Singapore is enhancing its public transport system with increasing railway connectivity and bus frequencies.
• LTA will be improving island-wide rail connectivity through expansion of the current rail network over the next 20 years.
• ComfortDelGro offers ESG exposure given its market-leading position in the taxi and bus segments in Singapore.
• Beyond Singapore, ComfortDelGro is on a constant lookout for acquisitions in countries where governments favour public transport over private transport. This includes the UK, Australia, Continental Europe and the Middle East.
• In order to tackle the growing population and road congestion problems, London’s Transport Strategy set out plans to reduce car dependency and it has pledged to cut the number of car journeys by 3m each day. This translates to increase in the number of people that walk, cycle and use public transportation to 80% by 2041, up from 64% in 2016.
• London Transport Strategy 2018 includes:
  • Increase proportion of people walking, cycling and taking public transportation to 80% by 2041, up from 64% in 2017.
  • Aim for 70% of Londoners to live within 400m of cycle route by 2041.
  • Restrict car parking provision within new developments.
  • Improve quality of bus services by reviewing and extending operating times of bus lanes, making greater provision for bus priority lanes.
• Meanwhile in Stockholm, Sweden city authorities have been increasing the supply of public transportation to reduce inner-city congestion. Steps to further improve air quality and regulate access to polluting vehicles include:
  • Invest in improvements to infrastructure for public transport and cycling.
  • Increase parking charges.
  • Promote car sharing.
  • Stimulate the purchase and use of cleaner cars.

ComfortDelGro - Financial analysis and forecasts

Topline and operating profit

• The bulk of ComfortDelGro’s earnings come from its BCM-based public transport services globally. Over the long run, its earnings base should become more defensive given its acquisition guideline, ie, acquire only operators operating under BCM or a similar scheme.
• On the other hand, its taxi and railway business are vulnerable to market risks.
• Barring any future acquisitions, we forecast FY20 public transport revenue to decline by 3.5% y-o-y, as we are anticipating a 30% overall fall in annual train ridership y-o-y amid Covid-19 outbreak for nine months. This is partially mitigated by the 7% fare hike implemented in Dec ’19. Excluding the fare hike, revenue would have been down 4.5% in our estimates.
• Fares are reviewed annually by the Public Transport Council to ensure they can keep up with changing costs of running a public transport system smoothly. Based on a formula (newly revised in 2018 to include network capacity factors to better reflect rising operating costs), public transport fares can be adjusted upwards or downwards.
• We are building in a 3.4% rise in FY21E revenue when the situation eases and the full impact of the Dec’19 fare hike is felt.
• Meanwhile, we expect a 25% fall in its taxi business due to SGD115m in rental rebates given to taxi drivers, as the rental rebates translate to revenue loss for ComfortDelGro.
• Going forward, we project a 23% recovery in the taxi segment in FY21E as rental rates normalise upon easing of Covid-19 measures.
• Meanwhile, EBIT margin for FY20E would mainly be hurt by the taxi segment, as operating cost should remain similar to that of FY19. This translates to a taxi EBIT margin of 4%, with overall margin projected to be 8.2%.

ComfortDelGro's balance sheet

• Our model did not take into account any acquisitions this year as management did not provide any guidance. That said, we are building in an increase in capex over the next three years as ComfortDelGro looks to expand its overseas business through acquisitions and as fleet replacement continues.
• Management is willing to spend up to SGD1b on new overseas acquisitions, but this is a potential war chest rather than a target amount to be spent.
• If the entire SGD1b is spent this year, net gearing would rise to 25%, which is still healthy as management is willing to gear up to a maximum of 40%.
• With or without acquisition, ComfortDelGro could sustain its 60% payout ratio as dividends have been well supported by free cashflow over the years.

ComfortDelGro's Valuation

• Barring earnings volatility this year due to exceptional rental rebates given to taxi drivers, we believe DCF is an appropriate valuation method given the company’s steady and strong cashflow. Cashflow should remain stable as ComfortDelGro shifts towards more BCM schemes for public transportation, while the taxi business normalises.
• We applied a WACC of 8.2%, with debt-to-capital ratio of 0.1x and derived a Target Price of SGD1.99 assuming a long-term growth of 1%. See attached PDF report for the sensitivity analysis on ComfortDelGro's target price. 
• Our Target Price implies FY21E/22E P/B of 1.2x, which is 2SD away from its long-term historical mean.
• Our Target Price implies 24.8x 2020E P/E, which is above its three-year historical valuation of 17.5x. However, our implied FY21E P/E drops sharply to 17.6x, which is in line with its 5-year historical mean.
• We believe five-year historical mean is particularly relevant as it captures the peak period of competition between taxis and private-hire vehicles between 2016 and early 2018, and the market’s eventual consolidation before Gojek’s entry into Singapore, as well as the revenue shift towards higher public transport mix.
• See ComfortDelGro Share Price; ComfortDelGro Target Price; ComfortDelGro Analyst Reports; ComfortDelGro Dividend History; ComfortDelGro Announcements; ComfortDelGro Latest News.

See attached 33-page PDF report for complete analysis.

Kareen Chan Maybank Kim Eng Research | https://www.maybank-ke.com.sg/ 2020-05-17

SGX Stock Analyst Report BUY INITIATE BUY 1.99 SAME 1.99