Land transport sector

Maybank Kim Eng Research, Nov 26

THE Fare Review Mechanism Committee (FRMC) recently proposed several changes to the existing fare-adjustment formula, which were subsequently accepted in full by the government. The inclusion of a rollover mechanism for annual fare adjustments is the biggest positive.

The changes made to certain components of the annual fare-review formula would also better align fare revisions to the cost structure of the Public Transport Operators (PTOs).

However, we are concerned over the proposal for the PTOs to contribute part of their fare revisions to the Public Transport Fund and await further clarity on this.

The Public Transport Council (PTC) is expected to announce its decision on a fare adjustment in 1Q2014.

With an estimated 8 per cent of accumulated fare revision not implemented in 2012/13, we expect significant fare hikes of 5 per cent per annum in the next three years, before reverting to a more normalised annual rise of 2.7 per cent.

Coupled with our long-term ridership forecasts of 2.3 per cent per annum, we expect sector revenue to be 43 per cent higher in 2018.

The Downtown line (DTL) to be operated by SBS Transit will open in three stages over the next four years. We believe that traffic cannibalisation would have a significant negative impact on SMRT once DTL Stage 2 operates in 2016.

While the opening of an extension to NSEWL's western leg in the same year could provide some respite, we still expect a net negative impact. We estimate the launch of DTL Stage 2 would put S$139 million or 17 per cent of SMRT's fare revenue base under threat.

When compared against the depressed profit base of SMRT, this potential income loss will be material (SMRT FY3/13 Ebit: S$127 million).

We believe the market has largely ignored this negative implication and expect growing concern in the years ahead.

We see the current business models for the PTOs as unsustainable and expect imminent changes.

Shifting to a tender-based bus operating model appears likely, as evidenced from the packages of routes tendered out by the LTA over the past year. We also expect a transition to the new rail financing (NRF) framework for all existing rail lines over the next few years.

However, the lack of clarity over transition terms for the existing rail network remains a key concern for SMRT.

With a bigger fare-based revenue exposure, SMRT will be a bigger beneficiary to the impending fare hike. However, we continue to question the attractiveness of the stock as an investment and maintain our negative view on SMRT due to negatives from:

1) Cannibalisation effects of the DTL;

2) Uncertain transition terms for its existing rail network; and

3) Elevated gearing driven by higher capital spending after prior years of under-investment.

Anchored by stable acquisition-led earnings growth from its overseas units, ComfortDelGro (CDG) is our preferred exposure to the sector.

Furthermore, CDG's valuation (15 times P/E) remains more attractive than SMRT (19 times P/E). Maintain "Sell" on SMRT (TP: S$0.90) and "Buy" on ComfortDelGro (TP: S$2.39).

Land transport sector: NEUTRAL

ComfortDelGro: BUY

SMRT: SELL