Singapore Land Transport

Kim Eng on 12 Jul 2012

Pair-trade working out well. Those who followed our recommendation in April for a long CDG – short SMRT pair trade would now be sitting on a pretty 10% gain for a period of just 3 months. Our recommendation remains valid as of today, as we stand by our SELL call for SMRT on concerns of maintenance costs and dividend uncertainty going forward, while CDG remains our preferred pick in the sector.

The Council has spoken. The Committee of Inquiry (COI) released its report with recommendations to improve the rail network and crisis management, most of which were directed at SMRT. Responsibility was apportioned to the Land Transport Authority (LTA) as well for events leading to the Dec 2011 rail disruptions. While the recommendations help cement our SELL rating for SMRT based on the uncertain maintenance outlook, a significant question remains of the LTA’s share of the maintenance burden that it will bear. Concerns of CDG suffering collateral damage appear unwarranted, as their involvement remains limited to LTA’s announcements of more stringent regulatory standards.

New investments in equipment could crimp cashflow. Out of the recommendations made by the COI, approximately a third of them call for investment in new maintenance or surveillance equipment. We make a further provision to capex of SGD10 mil for SMRT’s share of new equipment such as third rail assembly improvements, train-specific fault-detection systems, back-up battery replacements, emergency lighting and other staff-equipped detectors. We believe SMRT’s additional maintenance costs are sufficiently covered by our 13% YoY increase (+SGD10.9 mil) in maintenance cost forecasts for FY3/13.

LTA shares the blame, but what about cost? SMRT is likely to continue facing an uphill challenge to comply with all recommendations and yet maintain its dividend payout quantum. We do not rule out LTA bearing some of the structural asset upgrade costs especially since they are now being held partially responsible for events leading to the Dec 2011 disruptions.

SELL SMRT, we prefer CDG. We maintain our SELL call on SMRT pegged to 15x FY3/13 PER on renewed maintenance cost and dividend concerns going forward. We continue to prefer CDG for its global business model that provides diversification benefits and further avenues for growth, and believe it deserves a premium valuation pegged to 16x FY2012 PER.