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Sector Update Summary - Land Transport (26 November 2013)

Core Content

This report provides an analysis of the Singapore land transport sector, focusing on fare adjustments, operating model changes, and the impact of the Downtown Line (DTL) opening on sector players. It includes stock recommendations and valuation data for ComfortDelGro (CDG) and SMRT.

Main Points

Fare Hike Outlook

• The Public Transport Council (PTC) is expected to announce a fare adjustment in 1Q2014.
• The sector is projected to see a significant fare hike of 5% per annum over the next three years, leading to a 43% increase in sector revenue by 2018.
• Stagnating fares in recent years have hurt profitability, but the upcoming fare hike is expected to improve this.

Fare Adjustment Formula Changes

• The Fare Review Mechanism Committee (FRMC) revised the fare adjustment formula, which was accepted by the government.
• Key changes:
  • Energy index included to reflect rising diesel and electricity costs.
  • Productivity extraction factor reduced from 1.5% to 0.5%, allowing for higher fare adjustments.

Roll-over Mechanism

• A new roll-over mechanism for unimplemented fare adjustments is introduced, which allows for smoother fare revisions and avoids sharp fluctuations.

DTL Impact

• The DTL will open in three stages (2013, 2016, 2017) and is expected to significantly impact SMRT.
• DTL Stage 2 (2016) is projected to threaten SGD139m or 17% of SMRT's fare revenue base.
• DTL Stage 3 (2017) is expected to impact SMRT's rail network and SBST's bus operations in the eastern part of Singapore, though the revenue impact is hard to quantify due to extensive network coverage.

Ridership Growth

• Long-term ridership growth is forecasted at 2.3% per annum, driven by a projected 6.7 million population in Singapore by 2030 and a 75% public transport share target.
• This growth, combined with fare hikes, will support increased sector revenue.

Operating Model Changes

• Bus sector: Transition to a tender-based model is expected, which may increase competition and reduce the current monopolistic position of PTOs.
• Rail sector: The New Rail Financing (NRF) framework is being tested with the DTL, and if applied to the existing rail network, PTOs like SMRT will need to sell operating assets and pay license fees. This introduces uncertainty and financial risk.

Stock Recommendations

Key Concerns

• SMRT's vulnerability to DTL cannibalization.
• Uncertainty around rail transition terms for SMRT.
• Elevated gearing due to increased capital spending.
• Contribution to Public Transport Fund may reduce fare adjustment benefits.

Valuation Comparison

Sector Revenue Forecast

• 2018 Sector Revenue: Expected to be 43% higher due to fare hikes and ridership growth.
• Fare Revenue Pool: Approximately SGD1.6 billion annually, with SMRT and SBST contributing SGD0.84 billion and SGD0.74 billion respectively in 2012.

Investment Preference

• ComfortDelGro is preferred over SMRT due to:
  • Diversified earnings from overseas operations.
  • Lower exposure to rail transition uncertainty.
  • More attractive valuation compared to SMRT.
• SMRT is viewed negatively due to:
  • Cannibalization effects from DTL.
  • Uncertain transition terms for its rail network.
  • Higher gearing from capital spending.

Conclusion

• The sector is expected to benefit from imminent fare hikes, with SMRT being the primary beneficiary.
• However, the uncertainties around operating model changes and DTL impact make SMRT a risky investment.
• ComfortDelGro is seen as a more stable and attractive investment due to its diversified earnings, lower risk exposure, and better valuation.