Friday, 21 March 2014

Land Transport Sector

Kim Eng on 21 Mar 2014

  • Imminent move to a sustainable rail operating model but details on transition terms lacking.
  • Treatment of rail assets owned and operators’ asset purchase obligations are key obstacles to the transition in our view.
  • Maintain SELL on SMRT; retain BUY on ComfortDelGro. 
 SMRT has higher exposure to rail network than ComfortDelGro. Imminent transition to a new rail operating model The new rail financing (NRF) framework, introduced in 2010, is designed to give the Land Transport Authority (LTA) better control over the timing of capacity expansion for the rail network. Currently, only the Downtown Line (DTL) is on the NRF, although all other rail lines are expected to eventually transit to a similar model. But progress has been slow, perhaps due to the complicated process of unwinding contractual agreements under the old regime.

Details on transition lacking, SMRT more exposed
Other than the operating assets of the North South East West Line, which are owned by SMRT, all other rail assets are held on LTA’s balance sheet. Under the old regime, rail operators are required to
purchase them from the LTA in the future. We estimate these assets to be worth SGD2.4–3.1b as of 31 Mar 2013.

While the transition to a sustainable operating model is a positive move for the industry, the devil is in the details. The lack of clarity on the transition details convinces us that it is highly speculative to conclude that the terms will be favourable to shareholders. In particular, the treatment of rail assets owned and asset purchase obligations of the operators will have a profound impact on their profitability. In our view, the price at which assets are to be sold to LTA and future licensing charges are two key parameters to watch. As the largest rail operator, SMRT is highly exposed to the uncertainty surrounding the transition terms. We are less worried about ComfortDelGro (CDG), as its exposure is limited to its stake in SBS Transit or SBST (7% of market cap). Besides, SBST’s exposure is smaller because 1) DTL is already on the NRF framework, and 2) its purchase obligations are likely to be lower due to accumulated depreciation since 2003. Maintain SELL on SMRT and BUY on CDG.

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