Singapore Land Transport Sector - Land Transport Sector What will restructuring mean for the bus market in 2016? ... SMRT: impact of GCM on Singapore bus segment operating forecasts

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<ul><li><p>See important disclosures, including any required research certifications, beginning on page 28 </p><p>Singapore Consumer Discretionary </p><p>What's new: Singapores public transport landscape is set to undergo </p><p>extensive change. In the rail segment, details of regulatory reform and </p><p>asset acquisition are scant, and we believe these developments will only </p><p>gain traction after rail reliability obligations have been fulfilled, which we do </p><p>not expect to occur in the near term. Meanwhile, in the bus segment, the </p><p>transition to a new government contracting model (GCM) is imminent, and </p><p>we recommend that investors position themselves ahead of the events we </p><p>expect to play out in the run-up to, and following, the GCMs </p><p>implementation in September 2016. We expect shares in the sector to be </p><p>rerated over the coming months as clarity increases. </p><p>What's the impact: Given that we are drawing close to the GCMs </p><p>implementation, we incorporate its full impact into our forecasts despite the </p><p>lack of disclosure. Our recent discussions with new entrant Go-Ahead, as </p><p>well as our analysis of the London bus market, where a similar model has </p><p>been in place since 2000, strengthen our conviction that the transport </p><p>service providers under Daiwas coverage will be net beneficiaries of the </p><p>shift to the GCM, mainly as we foresee: 1) scope for operating-margin </p><p>enhancement as revenue risk is transferred to the government, 2) reduced </p><p>capex burdens as the government will assume asset ownership, and 3) </p><p>capital proceeds from a potential acquisition of existing bus assets. </p><p>After fine-tuning our margin assumptions for the bus segment, we estimate </p><p>the move to the GCM will account for 5-9% of our operating profit forecasts </p><p>for ComfortDelGro (CDG) for 2016-18E, and 4-7% of SMRTs for FY17-</p><p>19E. In terms of asset acquisitions, we believe a direct acquisition remains </p><p>the most sensible option for the regulator, and estimate net inflows of </p><p>around SGD566m and SGD44.6m for CDG and SMRT respectively. </p><p>What we recommend: We have a Positive rating on the sector. We </p><p>reaffirm our Buy (1) call on CDG (CD SP, SGD2.97) with a higher DCF-</p><p>based 12-month TP of SGD3.59 (from SGD3.38) and Underperform (4) </p><p>rating on SMRT (MRT SP, SGD1.58), after raising our DCF-based TP to </p><p>SGD1.41 (from SGD1.34). We continue to prefer CDG over SMRT, as we </p><p>believe the former is better placed to leverage this operational shift given </p><p>the bus segment is CDGs largest segment (32% of Singapore revenue vs. </p><p>SMRTs 19%). Further, its superior FCF profile, stronger balance sheet (net </p><p>cash of SGD229.2m as at end-2015 vs SMRTs net debt of SGD665.5m as </p><p>at end-FY15) and 2016E dividend yield of 3.3% looks attractive, while the </p><p>stock is trading at a 2016E PER of 19.7x (vs. SMRTs 24.7x for FY17E). </p><p>How we differ: We believe the attractiveness of the new bus model in the </p><p>Singapore market could be under-appreciated by some in the market. </p><p>18 March 2016 </p><p>Singapore Land Transport Sector </p><p>What will restructuring mean for the bus market in </p><p>2016? </p><p> In a pivotal year for the segment, we expect implementation of a new contracting model in September to be positive for existing operators </p><p> Government acquisition of CDG and SMRTs bus assets could take place by 3Q16 </p><p> We have a Positive sector rating; prefer CDG over SMRT for superior earnings growth and more attractive valuation </p><p>Key stock calls </p><p>Source: Daiwa forecasts </p><p>Jame Osman(65) 6321 3092</p><p>jame.osman@sg.daiwacm.com</p><p>New Prev.</p><p>ComfortDelGro Corp (CD SP)</p><p>Rating Buy Buy</p><p>Target 3.590 3.380</p><p>Upside p 20.9%</p><p>SMRT Corp (MRT SP)</p><p>Rating Underperform Underperform</p><p>Target 1.410 1.340</p><p>Downside q 11%</p></li><li><p>2 </p><p> Singapore Land Transport Sector: 18 March 2016 </p><p> How do we justify our view? </p><p>Growth outlook Valuation Earnings revisions </p><p>Growth outlook Singapore Land Transport Sector: net profit growth forecasts </p><p>(% YoY) </p><p>While we expect the transition to a new bus model in </p><p>Singapore in September 2016 to drive an expansion in </p><p>operating profit margins for CDG and SMRT, we believe </p><p>CDG will be the main beneficiary of this move due to its </p><p>greater exposure to the bus segment. </p><p>Further, our forecast 6.5% YoY decline in SMRTs FY17E </p><p>net profit (2016 forecasts in the chart) incorporates our </p><p>expectation of operating losses for its rail operation (MRT </p><p>and LRT), due to: 1) increased rail and maintenance </p><p>expenses, 2) the impact of the 1.9% fare reduction </p><p>implemented in December 2015, and 3) lower government </p><p>grants. </p><p>Source: Daiwa forecasts Note: SMRT FY17E forecasts shown above as 2016 forecasts due to March year-end </p><p>Valuation Singapore Land Transport Sector: 2016E valuations </p><p>The valuations of the land transport operators have seen a </p><p>rerating, likely driven by a positive shift in the markets </p><p>outlook toward the public transport sector following </p><p>favourable policy announcements signalling the </p><p>governments intention to encourage public transport </p><p>usage in the long term. </p><p>CDGs valuations look reasonable to us in the context of </p><p>its superior free cash flow generation, stronger balance </p><p>sheet and 2016E dividend yield of 3.3%, as well as its </p><p>stronger earnings growth prospects, relative to SMRT. </p><p> (x) PER PBR EV/EBITDA Dividend yield CDG 19.7 2.6 7.3 3.3% </p><p>SMRT 24.7 2.5 9.0 2.2% </p><p>Source: Companies, Daiwa forecasts Note: SMRTs valuations are for FY17E (March year-end) </p><p>Earnings revisions Singapore Land Transport Sector: consensus earnings-forecasts revisions </p><p>The Bloomberg-consensus EPS forecasts for 2016-17 </p><p>have seen downward revisions over the past 12 months, </p><p>mainly due to the announcement in October 2015 of a </p><p>1.9% reduction in fares by the government. SMRT has </p><p>seen sharper cuts due to its greater exposure to the </p><p>regulated fare environment (around 72% of revenue vs. </p><p>24% for CDG), as well as increased expectations of higher </p><p>repair and maintenance and staff costs arising from its rail-</p><p>enhancement projects. </p><p>2016 2017 </p><p>EPS EBITDA EPS EBITDA </p><p>CDG (4) (4) (4) (7) </p><p>SMRT (29) (8) (31) (17) </p><p>Source: Bloomberg </p><p>-7%</p><p>-2%</p><p>3%</p><p>8%</p><p>13%</p><p>2016 2017 2018</p><p>CDG SMRT</p></li><li><p>3 </p><p> Singapore Land Transport Sector: 18 March 2016 </p><p> Sector stocks: key indicators </p><p> Source: Bloomberg, Daiwa forecasts </p><p> Singapore Land Transport: timeline of GCM-related events </p><p>Date Details </p><p>May-14 LTA announces plans for new Government Contracting Model </p><p>Oct-14 Tender for Bulim package opened </p><p>Apr-15 Tender for Loyang package opened </p><p>May-15 Winner of Bulim package announced </p><p>Aug-15 SBS Transit announces transfer of BSEP buses to LTA </p><p>Nov-15 Winner of Loyang package announced </p><p>Dec-15 LTA announces it will take over SBST's 2016/17 bus purchase contracts; acquires 50 of its existing buses at NBV </p><p>Upcoming </p><p> 2Q16E Tender for third bus package (Mandai) </p><p>3Q16E Purchase of SBST/SMRT bus assets </p><p>4Q16E Award of third bus package </p><p>Sep-16 GCM takes effect - Tower Transit commences operations </p><p>Source: Companies, Land Transport Authority (LTA), Daiwa compiled </p><p> CDG: impact of GCM on Singapore bus segment operating forecasts </p><p> SMRT: impact of GCM on Singapore bus segment operating forecasts </p><p>SGD m 2014 2015E 2016E 2017E 2018E </p><p>Current model </p><p> Singapore bus revenues 777.4 848.8 883.1 918.7 955.8 </p><p>YoY revenue growth </p><p>9.2% 4.0% 4.0% 4.0% </p><p>Operating profit margin 1.6% 1.6% 1.6% 1.6% 1.6% </p><p>Segment operating profit 12.4 13.6 14.1 14.7 15.3 </p><p>Under proposed GCM </p><p> Singapore bus revenues 777.4 848.8 794.75 734.98 764.68 </p><p>YoY revenue growth </p><p>9.2% -6.4% -7.5% 4.0% </p><p>Operating profit margin 1.6% 1.6% 4.8% 8.0% 8.0% </p><p>Segment operating profit 12.4 13.6 38.1 58.8 61.2 </p><p>Incremental operating profit - - 24.0 44.1 45.9 </p><p>% increase to overall operating profit forecasts </p><p>5.1% 8.8% 9.0% </p><p>Assumptions </p><p> First 3 GCM packages are not won by either incumbent </p><p> 20% decline in revenues (according to % of bus routes lost) </p><p> SGD m FY15 FY16E FY17E FY18E FY19E </p><p>Current model </p><p> Bus segment revenues (non-consolidated) 238.6 250.7 260.8 271.3 282.3 </p><p>YoY revenue growth </p><p>5.1% 4.0% 4.0% 4.0% </p><p>Operating profit margin -2.7% 4.0% 1.5% 1.5% 1.5% </p><p>Segment operating profit (6.5) 10.0 3.9 4.1 4.2 </p><p>Under proposed GCM </p><p> Bus segment revenues 238.6 250.7 234.7 217.0 225.8 </p><p>YoY revenue growth </p><p>5.1% -6.4% -7.5% 4.0% </p><p>Operating profit margin -2.7% 4.0% 3.8% 6.0% 6.0% </p><p>Segment operating profit (6.5) 10.0 8.9 13.0 13.5 </p><p>Incremental operating profit - - 5.0 9.0 9.3 </p><p>% increase to overall operating profit forecasts </p><p>4.1% 7.1% 7.0% </p><p>Assumptions </p><p> First 3 GCM packages are not won by either incumbent </p><p> 20% decline in revenues (according to % of bus routes lost) </p><p>Source: Company, Daiwa estimates Note: CDG stopped disclosing segmental Singapore bus revenue in 4Q15; hence full-year </p><p>2015 Singapore bus revenue not available </p><p> Source: Company, Daiwa estimates </p><p> CDG: proceeds from the potential government acquisition of Singapore bus assets </p><p> SMRT: proceeds from the potential government acquisition of bus assets </p><p>(SGD m) Amount </p><p>SBST segmental bus assets (2014) at NBV 1,095 </p><p>SBST segmental bus liabilities (2014) 411 </p><p>Net asset value 684 </p><p>Less: BSEP buses 118 </p><p>Total potential net proceeds 566 </p><p>Per share (SGD) 0.27 </p><p>SBST accumulated profit (2014) 253 </p><p>Potential payout at CDG level 0.12 </p><p> (SGD m) Amount </p><p>SMRT segmental bus assets (FY15) 393.1 </p><p>SMRT segmental bus liabilities (FY15) 348.5 </p><p>Net asset value 44.6 </p><p>Potential net proceeds 44.6 </p><p>Per share (SGD) 0.02 </p><p>Source: Company, Daiwa estimates </p><p> Source: Company, Daiwa estimates </p><p>Share</p><p>Company Name Stock code Price New Prev. New Prev. % chg New Prev. % chg New Prev. % chg</p><p>ComfortDelGro Corp CD SP 2.970 Buy Buy 3.590 3.380 6.2% 0.151 0.153 (1.6%) 0.167 0.171 (2.6%)</p><p>SMRT Corp MRT SP 1.585 Underperform Underperform 1.410 1.340 5.2% 0.069 0.069 0.0% 0.064 0.065 (1.8%)</p><p>Rating Target price (local curr.) FY1</p><p>EPS (local curr.)</p><p>FY2</p></li><li><p>4 </p><p> Singapore Land Transport Sector: 18 March 2016 </p><p>Table of contents </p><p>Spotlight on the bus segment ................................................................................. 5 </p><p>A strong push toward greater public transport use .............................................................5 </p><p>GCM: a recap ....................................................................................................................7 </p><p>How could the market evolve? ...........................................................................................8 </p><p>Assessing the impact on financials .................................................................................. 10 </p><p>Key forecasts ................................................................................................................... 14 </p><p>Valuations and ratings ..................................................................................................... 16 </p><p>Key investment risks ........................................................................................................ 18 </p><p>Company Section </p><p>ComfortDelGro Corp ........................................................................................................ 20 </p><p>SMRT Corp ...................................................................................................................... 23 </p></li><li><p>5 </p><p> Singapore Land Transport Sector: 18 March 2016 </p><p>Spotlight on the bus segment </p><p>A strong push toward greater public transport use </p><p>The public bus segment will see the biggest restructuring </p><p>2016 will be a pivotal year for the public transport landscape in Singapore, particularly in </p><p>the bus segment, with the transition to a new government contracting model (GCM) in </p><p>September 2016. We believe investors should position themselves ahead of the events </p><p>that we expect to happen in the lead-up to, and following, the GCMs implementation. </p><p>Despite the likely increase in competition within the bus segment, we believe the transport </p><p>service providers under our coverage will still be net beneficiaries of the shift to the new </p><p>GCM. This is mainly because revenue and ridership risks will be transferred to the </p><p>government under the new system and, as a result, the operators will no longer be </p><p>subjected to a regulated fare pricing environment, which has historically been an </p><p>impediment to the segments profitability. </p><p>While there is uncertainty over the level at which margins for the operators could settle </p><p>post-GCM, our recent discussions with new entrant Go-Ahead, as well as our analysis of </p><p>the London bus market, where a similar bus model is in place, strengthen our conviction </p><p>that operating margins of the existing operators will expand significantly from current </p><p>levels. After fine-tuning our margin assumptions for the Singapore bus segment for CDG </p><p>and SMRT to improve to 6-8% by 2017 (from 8-10% previously), from around 0-2% levels </p><p>currently, we estimate the move to the GCM will account for 5-9% of our overall operating </p><p>profit forecasts for CDG for 2016-18, and 4-7% of our forecasts for SMRT for FY17-19E. </p><p>The other key event investors are waiting on is greater clarity over the potential acquisition </p><p>of bus assets of CDG and SMRT by the government. We believe that a direct acquisition </p><p>remains the most sensible option to ensure consistency among all operators. And recent </p><p>indicators suggest that this could indeed happen in the near term the government </p><p>announced in December 2015 that it will purchase 50 of CDGs newer buses at net book </p><p>value. We expect this to be the benchmark used going forward. Despite the overall lack of </p><p>disclosure from both the government and operators, we estimate net inflows of around </p><p>SGD566m and SGD44.6m for CDG and SMRT, respectively. We believe that an </p><p>acquisition could occur by 3Q16, and we may obtain further clarity as early as 24 March, </p><p>the date of the Singapore Budget 2016 announcement. </p><p> Singapore Land Transport: timeline of bus GCM-related events </p><p>Date Details </p><p>May-14 LTA announces plans for new Government Contracting Model </p><p>Oct-14 Tender for Bulim package opened </p><p>Apr-15 Tender for Loyang package opened </p><p>May-15 Winner of Bulim package announced </p><p>Aug-15 SBS Transit announces transfer of BSEP buses to LTA </p><p>Nov-15 Winner of Loyang package announced </p><p>Dec-15 LTA announces it will take over SBST's 2016/17 bus purchase contracts; acquires 50 of its existing buses at NBV </p><p>Upcoming </p><p> 2Q16E Tender for third bus package (Mandai) </p><p>3Q16E Purchase of SBST/SMRT bus assets </p><p>4Q16E Award of third bus package </p><p>Sep-16 GCM takes effect - Tower Transit commences operations </p><p>Source: Companies, LTA, Daiwa compiled </p><p>Government policies remain strongly supportive of the sector </p><p>The new bus model underscores the Singapore governments push toward greater usage </p><p>of public transport services in the land-scarce city state. In addition to the bus segment, the </p><p>government has undertaken a range of measures, both in the form of policy </p><p>implementation and greater infrastructure development, including: 1) curbing private </p><p>vehicle usage by reducing annual vehicle growth to just 0.5%, 2) plans to double the length </p><p>of the rail network to 360km by 2030, in addition to introducing new rail reform measures, </p><p>2016: a pivotal year for </p><p>Singapore public </p><p>transport...</p></li></ul>

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