SBS Transit - CGS-CIMB Research 2020-09-18: Time To Hop On

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SBS TRANSIT LTD (SGX:S61)

SBS Transit - Time To Hop On

• We are the first to initiate on SBS Transit, with an ADD rating and Target Price of S$3.40. We believe market hasn’t priced in its recovery scenario and potential catalysts.
• We expect public transport ridership to return to c.90% of pre-Covid levels by FY21F, which could drive net profit recovery (+35% y-o-y) for the year.
• Compared to ComfortDelGro, SBS Transit offers direct exposure to potential catalysts such as bus package tender wins and rail financing policy reform.

SBS Transit - Company background

• SBS Transit (SGX:S61) is one of two multi-modal public transport operators in Singapore. It was established in 1973 through a merger of three existing private bus companies, namely the Amalgamated Bus Company, Associated Bus Services and the United Bus Company, as part of a government-led initiative to increase efficiency and achieve scale economies.
• SBS Transit is 74.4% owned by ComfortDelGro (SGX:C52) (See ComfortDelGro Share Price; ComfortDelGro Target Price; ComfortDelGro Analyst Reports) and has been listed on the Singapore Exchange (SGX) since 1978.
• SBS Transit has three main business segments:
  • Under its transport services segments (96% of FY19 revenue), SBS Transit operates both public bus and rail services in Singapore.
  • Other commercial services, which comprise advertising and rental income, accounted for 4% of FY19 revenue.

Public bus

• SBS Transit currently operates 9 of the 14 bus packages available in Singapore. In 2019, SBS Transit managed 223 bus routes, or about 31,000 trips a day. According to its FY19 annual report, SBS Transit has a 61% market share of the Singapore public bus industry by number of bus routes.
• SBS Transit’s public bus operational framework was converted to the Bus Contracting Model (BCM) in Sep 2016 (for more information regarding the switch in industry framework, please refer to industry background section, pages 14-16 in PDF report attached below).
• Under the BCM framework, SBS Transit switched to an asset-lite model, where it operates bus packages tendered out by the government. Buses and depots are owned by the government. Fare revenue collected from the provision of bus services is retained by LTA, while service fees paid to SBS Transit are indexed to changes in wage levels, inflation and fuel cost.
• We think that the switch to BCM was a big positive to SBS Transit, as it benefits from
  1. better profitability,
  2. more stable earnings, and
  3. improved balance sheet position, given the strong cash flow generation with the shift to an asset-lite model.
• Since the transition to the BCM model, SBS Transit has seen an improvement in net margins.
• SBS Transit’s free cash flow has also turned positive since 2016 with the transition to BCM, due to declining capex requirements. In line with the stronger cash generation, SBS Transit’s net gearing fell significantly to 10.4% by end-FY19, versus its peak of 154% at end-FY14.

Rail services

• On the rail services front, SBS Transit operates three rail lines in Singapore:
  1. North East Line (NEL) with 16 stations covering 20km;
  2. Sengkang Punggol Light Rail Transit (SPLRT) with 28 stations; and
  3. Downtown Line (DTL) with 34 stations. This translates to a 36.3% market share by rail stations in Singapore, as at end- 2019.
• DTL was the latest addition to SBS Transit’s rail operations, which commenced operations in 3 stages between 2013 and 2017.
• Unlike the public bus services, SBS Transit has to bear fare revenue risk for its rail operations (for detailed information about the latest rail operational framework, please refer to our industry section, pages 17-19 in PDF report attached below).
• We understand that SBS Transit’s rail operations in FY19 remained loss-making, mainly due to its DTL operations, which have been suffering from lower-than-expected ridership.

Other commercial services

• SBS Transit’s other commercial services include advertising and commercial space rental. Under advertising, SBS Transit has an extensive portfolio of advertising spaces on its trains, buses and interchanges. Commercial space rental is relating to the lease of commercial space at bus interchanges and train stations, to tenants including convenience stores, food and beverage outlets and wellness clinics and salons. In 2019, the commercial spaces were 97% leased out.

SBS Transit - Investment thesis

Leading public transport operator in Singapore

• SBS Transit is a multi-modal public transport operator in Singapore which is majority-owned (74.4% stake) by ComfortDelGro. As a beneficiary of Singapore’s public policy that favours public transport over private vehicle ownership, SBS Transit offers long-term structural growth, in our view.
• SBS Transit holds a market leadership position in the public bus industry (61% market share by bus routes in 2019), which generates defensive earnings and stable cash flow under the Bus Contracting Model (BCM). Under the BCM, the government will own all bus operating assets and infrastructure, such as bus depots, which will then be contracted out to public transport operators (PTOs) via competitive tendering with the Land Transport Authority (LTA). Under the BCM, fare revenues will be retained by the government, while PTOs will be paid service fees for operating the leased assets and bus routes.
• SBS Transit also operates three of the eight existing rail lines in Singapore under the New Rail Financing Framework (NRFF).
• While SBS Transit has to bear the revenue risk for its rail operations, the railway operational framework offers some level of protection against
  1. revenue risks arising from uncertainties in ridership and fares, as well as
  2. EBIT shortfall, should EBIT margin fall below 3.5%.
• The level of protection is limited by the amount of licence charge payable by SBS Transit for the year.

Worst is over; expect gradual recovery ahead

• Singapore entered a two-month circuit breaker period from 7 Apr to 1 Jun, with non-essential physical workspaces and schools shut to stem the spread of COVID-19. This resulted in a steep drop in public transport ridership. As a result, SBS Transit’s revenue in 2Q20 declined by 26.3% y-o-y, while its operating profit fell 42.3% y-o-y to S$17.6m, after taking into account government reliefs of S$61.6m.
• Post circuit breaker, the government embarked on a three-phased approach to resume activities safely. As of 15 Sep, Singapore remains in Phase 2 of reopening.
• Since the lifting of the circuit breaker, we note that rail ridership has improved steadily, albeit at a pace that has been slower than our expectations. Rail ridership in Jul was at c.55% of pre-COVID-19 levels (July: 50%), mainly due to working from home (WFH) remaining as the default option in the current phase of reopening. Google’s mobility trend also shows that Singaporeans are slowly returning to work and resuming social activities.
• To see a faster ridership recovery in Singapore, we believe either one of the following has to happen:
  1. relaxation of work-from-home arrangements, or
  2. earlier transition into phase 3 of reopening.
• Work-from-home is currently still the default option for employees in Singapore (for phase 1 and 2 of reopening), unless they have a demonstrable need to return to the workplace. However, we understand from The Straits Times, a Singapore based news media, that Singapore’s multi-ministry taskforce is reviewing the work-from-home arrangements and may modify the rules, following appeals and feedback from employers that have requested for more flexibility. With community cases currently at low levels, we see room for further relaxation of safe distancing measures, which could potentially aid ridership recovery.

JSS to ease cost pressure

• Under the Job Support Scheme (JSS), the Singapore government will co-fund between 25% and 75% of the first S$4,600 of gross monthly wages paid to each local employee for ten months (up to Aug 2020), followed by wage support of between 10% and 50% in the subsequent seven months (till Mar 2021). In addition to supporting firms during the circuit breaker period, wage support for the months of Apr and May 2020 will be topped-up to 75% for all firms, regardless of sector.
• SBS Transit bus operations qualify for the lowest tier of 25%/10% wage support for the 2 periods respectively. On the other hand, its rail operations qualify for higher wage support of 50%/30% for the 2 periods. For our JSS estimates, we have used a base of S$3,800 and 6,600 qualifying staff strength in our calculations (we assume 60% of SBS Transit’s employees based in Singapore are locals), while assuming the employee split between bus and rail operations to be 80% and 20% respectively.
• Based on our estimates, total government relief that SBS Transit is entitled to receive in FY20F/21F will amount to S$110m/S$28m respectively. We note that SBS Transit had received government relief totalling S$61.6m in its 1HFY20.

Two bus packages up for tender in 2020F

• The LTA put up a call for tender for the Bulim and Sembawang-Yishun bus packages in Nov 2019. The Sembawang-Yishun bus package (currently operated by SMRT Buses) marks the fifth tendered contract for the bus contracting model, while the Bulim bus package (currently operated by Tower Transit) is currently up for its second term under the bus contracting model.
• According to the tender details as published on government procurement portal GeBIZ, bids were submitted by five hopeful operators, namely:
  1. SBS Transit,
  2. SMRT Buses,
  3. The Go-Ahead Group,
  4. Tower Transit Singapore, and
  5. Guangzhou Public Transportation Group No. 3 Bus Co., Ltd.
• We expect the tender results to be announced in 2H20F. As both contracts up for bidding are currently not being operated by SBS Transit, any tender wins will be a positive surprise to our EPS estimates, as we have not assumed the contract wins in our forecasts.
• SBS Transit has won two of the four bus package tenders so far, in a two-envelope bidding process where the quality of the proposal is assessed before pricing. For example, we note that LTA awarded the Bukit Merah bus package to SBS Transit largely on quality factors, with price not the overriding factor, as SBS Transit’s winning bid of S$472m was slightly above the median bid of S$466m.
• LTA said that SBS Transit was awarded the bus package for reasons that included a comprehensive understanding of ground operational conditions and strong competence in bus service scheduling to enable the optimal deployment of buses and resources to meet travel demand. LTA also highlighted SBS Transit’s innovative IT solutions for infrastructure and asset maintenance, as well as security management, with the development of several in-house mobile applications for staff to report defects and incidents.

COVID-19: A silver lining?

• Due to the circuit breaker in Singapore, public transport ridership has declined significantly, impacting public transport operators’ financial performance. According to a written response to a parliamentary question published on the Ministry of Transport’s website on 5 May 2020, ex-Transport Minister Khaw Boon Wan noted that ridership has dropped by 75% for buses and 84% for trains in Apr 2020 (from the period before the outbreak), due to the government’s circuit breaker measures. Fare revenue has also dropped by about 80% during the same period.
• Meanwhile, public transport operators continue to incur operating costs, as service capacity and headways were largely preserved to ensure commuters can maintain safe distancing during the period. On top of that, there are additional costs incurred due to the
  1. increased cleaning of buses, trains and public transport premises,
  2. provision of protective equipment for frontline workers, as well as
  3. to cover the accommodation costs of Malaysian bus captains affected by Malaysia’s Movement Control Order (MCO) that prohibited Malaysians from travelling out of the country.
• Mr. Khaw noted that these costs are not adequately covered by current fares. However, the authorities will have to see how demand for public transport evolves after the pandemic is over before deciding on changes in financing models for public transport.
• For the time being, we believe that the government is providing relief to the public transport operators in the form of higher Jobs Support Scheme (JSS) support. We note that in the Fortitude Budget announced on 26 May, rail operators in Singapore were reclassified to a different JSS tier, making them eligible for higher wage support of 50% (previously 25%). The JSS was later extended into 1H21, and we estimate total support for SBS Transit to be c.S$138m across the two years.
• In the medium term, should public transport ridership not recover to pre-COVID-19 levels (due to new norms of increased work from home arrangements, etc.), we believe this will be an impetus for the government to implement changes to the rail financing model into a structure that is similar to the Bus Contracting Model. We note that the rail financing framework where the government takes on fare revenue risk currently exists in Singapore for the operations of Thomson East Coast Line (albeit a temporary one), and highlight key features of the model below:

Case study: Thomson East Coast Line (TEL) contracting model

• The latest addition to the rail network – the Thomson East Coast Line (TEL) – operates on a new framework where the government will bear revenue risk on operations.
• TEL is expected by the Land Transport Authority to be fully operational by 2024F and will begin opening in stages from 2020. Due to the staged opening, TEL’s financing framework differs from the rest of the existing rails lines in Singapore. As part of the TEL contract, LTA will pilot a new Incentives-Disincentives (ID) framework, with the rail operator receiving a service fee for the operations of the rail line. An incentive payment will be granted if the operator outperforms indicators, while conversely a service fee deduction would be made if it does not meet expectations. Performance will be evaluated through multiple reliability indicators, operational and maintenance audits and customer satisfaction surveys. TEL’s non-fare business (which includes commercial spaces and advertising spaces at the stations, trains and associated infrastructure) was issued through a separate tender.
• According to LTA, this temporary financing model for TEL will run for nine years, with a possible two-year extension. Once the ridership stabilises and the licence expires, TEL will revert to the NRFF for subsequent tenders.

SBS Transit - Potential for higher dividend payout

• With the shift to BCM in 2016, SBS Transit’s bus operations transitioned into an asset light business model, where the company now leases buses and other operating assets from the government instead of having the need to incur capex. Due to the declining capex requirements, SBS Transit’s free cash flow has turned positive since 2016.
• In line with the stronger cash generation, SBS Transit’s net gearing fell significantly to 10.4% by end-FY19, versus its peak of 154% in end-FY14. We forecast SBS Transit could go into a net cash position as early as end-FY20F. SBS Transit has a dividend policy of distributing 50% of net profit to its shareholders. We believe that with the on-going improving balance sheet strength, SBS Transit could potentially increase its dividend payout ratio in the medium term, as its parent company ComfortDelGro had a dividend payout ratio of 80% in FY19. See SBS Transit Dividend History; ComfortDelGro Dividend History.

Initiate coverage on SBS Transit with ADD rating and Target Price of S$3.40

• Operationally, we believe the worst is over for SBS Transit, and see strong earnings (+35% y-o-y) recovery in FY21F. The recent share price weakness offers a good opportunity for investors to accumulate the stock, which is trading at 11.7x CY21F P/E, while offering a dividend yield of 4.3%.
• As a beneficiary of Singapore’s public policy which favours public transport over private vehicle ownership, SBS Transit offers long-term structural growth, in our view. We initiate coverage on SBS Transit with an ADD rating and Target Price of S$3.40, based on 14.2x CY21F P/E (SBS Transit’s five-year historical mean). We value SBS Transit using the P/E valuation as we think this methodology allows the incorporation of near-term catalysts and risks. We believe the 5-year historical mean is particularly relevant as it captures the shift to the latest public transport financing framework in Singapore.
• See SBS Transit Share Price; SBS Transit Target Price; SBS Transit Analyst Reports; SBS Transit Dividend History; SBS Transit Announcements; SBS Transit Latest News.
• Based on its historical P/E, SBS Transit typically trades at a c.8% discount to its closest peer ComfortDelGro, mainly due to the lower liquidity of the stock. Currently, SBS Transit trades at a wider discount of c.15% to ComfortDelGro. We think the market has yet to factor in the recovery scenario and potential catalysts for SBS Transit.
• Potential re-rating catalysts include:
  1. faster-than-expected ridership recovery,
  2. positive update from bus package tenders in 2H20F, and
  3. potential rail financing framework reforms.
• Downside risks to our Add call include:
  1. slow pace of rail ridership recovery,
  2. SBS Transit losing market share in the public bus segment, as well as
  3. faster-than-expected increases in operational costs.

ONG Khang Chuen CFA CGS-CIMB Research | Darren ONG CGS-CIMB Research | https://www.cgs-cimb.com 2020-09-18

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