Singapore Industrials 2 December 2015 SMRT Corp (MRT SP) SMRT Corp Target price: SGD1.31 Share price (1 Dec): SGD1.46 | Up/downside: -10.0% Initiation: not time to get on board yet Rail segment operating losses look set to persist over medium term Jame Osman (65) 6321 3092 Market expectations of a new rail model appear unfounded to us [email protected] Initiating coverage with Underperform (4); TP of SGD1.31 Investment case: We initiate coverage of SMRT Corp (SMRT) with an Share price performance Underperform (4) rating. While the Singapore Government’s overhaul of the (SGD) (%) public transport sector across rail and bus segments signals a more 1.8 110 favourable outlook for incumbent players, we believe the bus operators are 1.6 103 positioned to benefit from an arguably more attractive change in the 1.5 95 1.3 88 business model than the rail segment, mainly as revenue and ridership 1.1 80 risks will be effectively transferred to the government in the case of the Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 former. SMRT (LHS) Relative to FSSTI (RHS) Considering that the rail business is SMRT’s largest segment (53% of FY15 12-month range 1.14-1.80 revenue), while the bus segment is ComfortDelGro’s (CDG) (CD SP, Market cap (USDbn) 1.57 SGD2.96, Buy [1]) largest segment (32% of its Singapore revenue), CDG 3m avg daily turnover (USDm) 2.18 appears better placed to leverage this shift in the operational landscape. Shares outstanding (m) 1,522 Major shareholder Temasek Holdings (54.2%) Accordingly, we recommend investors seeking exposure to the defensive Singapore transport services sector to switch from SMRT to CDG. Financial summary (SGD) Meanwhile, we forecast the operating losses for SMRT’s rail segment to Year to 31 Mar 16E 17E 18E persist over FY16-18, as it grapples with dealing with network disruptions, Revenue (m) 1,305 1,309 1,321 while concurrently executing its rail-enhancement projects. Operating profit (m) 117 125 134 Net profit (m) 88 94 99 Core EPS (fully-diluted) 0.058 0.061 0.065 Finally, market expectations of a positive outcome for rail reforms in the EPS change (%) (3.1) 6.1 6.2 near term appear unfounded to us, given the lack of clarity – comments Daiwa vs Cons. EPS (%) 1.4 (1.0) (16.5) made by both the former and current transport minister suggest instead PER (x) 25.2 23.7 22.3 Dividend yield (%) 2.2 2.3 2.5 that the central agenda remains on improving Singapore’s rail reliability DPS 0.032 0.034 0.036 before addressing asset acquisitions. We believe negotiations between PBR (x) 2.5 2.4 2.2 SMRT and the government will gain traction only after the operator has EV/EBITDA (x) 9.0 8.5 8.2 ROE (%) 10.0 10.2 10.3 fulfilled its obligations to return rail network reliability to satisfactory levels Source: FactSet, Daiwa forecasts under its existing licence requirements – indicating a timeline that could stretch beyond 2018. Catalysts: In the near term, we see the following derating catalysts: 1) news flow suggesting a delay in the implementation of a new rail model, 2) a sharper-than-expected deterioration in the rail segment’s margin, driven by higher repair/maintenance expenses, and to a lesser extent, 3) further major service disruptions to its network, which may result in significant penalties imposed by the regulator. Valuation: We adopt a DCF-based approach to value SMRT’s shares, deriving a 12-month target price of SGD1.31. We value SMRT with the following inputs: a WACC of 7.2%, comprising a 6% equity-risk premium, risk-free rate of 2.6% and a terminal FCF growth rate of 1.0%. Risks: The main risks to our call would be regulatory risks in the form of positive rail reforms as well as a decrease in labour costs. See important disclosures, including any required research certifications, beginning on page 31 SMRT Corp (MRT SP): 2 December 2015 Table of contents Getting back on track ............................................................................................... 6 Investment thesis ...............................................................................................................6 Rail: network upgrades weigh on operational performance ................................................8 Bus: transitioning to an asset-light operating model .........................................................14 Taxi business: muted growth ...........................................................................................17 Rental: lack of clear catalysts ...........................................................................................19 Financial analysis ............................................................................................................21 Valuation..........................................................................................................................23 Investment risks ...............................................................................................................25 Shareholding structure and key management ..................................................................26 Appendix 1: Singapore rail network ......................................................................27 2 SMRT Corp (MRT SP): 2 December 2015 How do we justify our view? Growth outlook Valuation Earnings revisions Growth outlook SM RT: operating margin and net-profit forecasts Overall, we forecast a net profit (PATMI) CAGR of 3.0% SGD m over the FY15-18 period, largely driven by an expected 170 25% improvement in the operating margin for its bus segment, 150 20% following the industry’s transition to the new government 130 contracting model (GCM) in August 2016. Meanwhile, we 15% 110 forecast continued operating losses for the rail segment 10% over the FY15-18 period, as we expect the company’s rail- 90 network enhancement initiatives to be a multi-year 70 5% endeavour. 50 0% FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E Net profit (PATMI) (LHS) Operating margin (RHS) Source: Company, Daiwa forecasts SM RT: 12-month forward PER (x) Valuation The stock is currently trading at a 2016E PER of 25.2x, 12M forward PER (x) which is above its past-10-year mean of 20.6x. Our target 43 price of SGD1.31 implies a 2016E PER of 22.6x. While the 38 +2 stdev market could possibly be pricing in expectations of a 33 +1 stdev transition by the rail segment to a new rail model, we 28 believe negotiations between the government and SMRT 23 Mean will only gain traction after the company has fulfilled its 18 obligations to return network reliability to satisfactory levels -1 stdev 13 under its existing licence requirements, indicating a -2 stdev timeline that could stretch beyond 2018. 8 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Source: Bloomberg, Daiwa forecasts Earnings revisions SMRT: Bloomberg EPS consensus revisions The Bloomberg consensus EPS forecasts for FY16-17 SGD SGD have seen downward revisions of 14-23% over the past 12 0.10 1.8 1.7 months, which we attribute mainly to increased 0.09 1.6 0.08 expectations of higher repair and maintenance and staff 1.5 costs, as well as the announcement of a 1.9% reduction in 0.07 1.4 1.3 fare prices. Looking ahead, management has indicated 0.06 that it expects the operating margin to remain depressed 1.2 0.05 on elevated repair and maintenance expenses, as well as 1.1 the expansion of its engineering workforce, resulting in 0.04 1 higher staff costs. Jul-15 Apr-15 Oct-15 Jan-15 Jun-15 Mar-15 Feb-15 Nov-15 Nov-14 Dec-14 Aug-15 Sep-15 May-15 FY16 EPS FY17 EPS Price Source: Bloomberg 3 SMRT Corp (MRT SP): 2 December 2015 Financial summary Key assumptions Year to 31 Mar 2011 2012 2013 2014 2015 2016E 2017E 2018E Operating margin - Bus (%) (0.8) (5.3) (15.0) (13.0) (2.7) 3.0 4.8 8.0 Operating margin - Taxi (%) (2.1) 2.4 4.9 7.3 9.6 13.0 10.0 10.0 Operating margin - MRT (%) 21.5 16.0 10.7 0.9 2.1 (2.5) (2.0) (2.0) Operating margin - LRT (%) (3.8) (3.3) (9.8) (20.0) (38.7) (55.0) (50.0) (45.0) Operating margin - Rental (%) 77.5 77.3 75.8 75.2 66.1 60.0 62.0 62.0 Profit and loss (SGDm) Year to 31 Mar 2011 2012 2013 2014 2015 2016E 2017E 2018E Rail 537 580 619 634 654 680 694 714 Bus 213 220 211 218 238 248 232 215 Other Revenue 220 257 290 312 343 377 384 392 Total Revenue 970 1,057 1,119 1,164 1,236 1,305 1,309 1,321 Other income 20 22 36 42 58 65 50 50 COGS (514) (613) (690) (739) (756) (802) (837) (869) SG&A 0 0 0 0 0 0 0 0 Other op.expenses (280) (318) (355) (383) (417) (451) (397) (369) Operating profit 196 149 110 84 121 117 125 134 Net-interest inc./(exp.) (5) (5) (5) (9) (11) (14) (15) (17) Assoc/forex/extraord./others 2 3 (0) (0) 1 4 4 4 Pre-tax profit 192 147 105 75 111 107 114 121 Tax (31) (27) (22) (13) (20) (20) (21) (22) Min. int./pref. div./others 0 0 0 0 1 1 1 1 Net profit (reported) 161 120 83 62 91 88 94 99 Net profit (adjusted) 161 120 83 62 91 88 94 99 EPS (reported)(SGD) 0.106 0.079 0.055 0.041 0.060 0.058 0.061 0.065 EPS (adjusted)(SGD) 0.106 0.079 0.055 0.041 0.060 0.058 0.061 0.065 EPS (adjusted fully-diluted)(SGD) 0.106 0.079 0.055 0.041 0.060 0.058 0.061 0.065 DPS (SGD) 0.085 0.075 0.025 0.022 0.033 0.032 0.034 0.036 EBIT 196 149 110 84 121 117 125 134 EBITDA 315 278 261 256 314 331 356 378 Cash flow (SGDm) Year to 31 Mar 2011 2012 2013 2014 2015 2016E 2017E 2018E Profit before tax 192 147 105 75 111 107 114 121 Depreciation and amortisation 135 163 178 181 203 224 240 254 Tax paid (32) (43) (15) (5) (9) (20) (21) (22) Change in working capital (14) 11 (19) (13) (10)