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Analysts: 30% Upside Despite SMRT’s Poor Q1
Aspire, Hot Picks | 15 September 2015
By: Lim Si Jie
Articles (169) Profile

Analysts' update as at 15/09/15

SMRT Corporation Ltd’s (SMRT) recently announced 1QFY16 results saw its Profit After Tax and Minority Interests (PATMI) decline 10 percent year-on-year (YoY) to S$20.1M on the back of a 5.6 percent drop in operating profit to S$27.7M.

While analysts are forecasting that there could be more short-term headwinds, SMRT continues to be a key beneficiary of longer-term catalysts. With positive longer-term outlook driven by regulatory changes, SMRT continues to receive a BUY call from research houses.

Loss From Train Operations Continues

SMRT’s 1Q revenue growth of 7.8 percent YoY was in line with analyst expectations. The revenue of non-fare business that grew by 12.7 percent was driven mainly by taxi and rental segments, though it was negated by elevated group operational expenditure.

Despite the revenue growth, rail operations incurred an S$5.7M operating loss in 1QFY16 compared to an S$4.3M profit in 1QFY15. A 6.4 percent quarter on quarter increase in staff costs arising from a higher headcount was the key reason for missing market forecasts for earnings. Higher-than-expected energy expenses as well as repair and maintenance costs (+19.6 percent YoY) were also contributory factors.

Compared with S$5.5M operating loss in 1QFY15, bus operations recorded a profit of S$1.5M in 1QFY16 mainly due to higher revenue and lower diesel costs. 1QFY16 taxi operating profit grew 32.2 percent YoY to S$5.5M, which is perhaps attributable to a larger fleet.

While the rail business recorded its second consecutive quarterly loss, other business segments recorded mainly positive Earnings Before Interest & Tax (EBIT) growth. Rental operating profit rose 5.3 percent to S$21.1M with contribution from the Kallang Wave Mall (KWM), but rental operating margin declined 13.4 ppt to 64.2 percent.

Potential Fines for SMRT

Based on amendments to the Rapid Transit Systems Bill back in 2014, we note that SMRT could face a maximum fine of up to 10 percent of its annual fare revenue (approx $50m) due to its massive rail breakdown in July.

It is unlikely that LTA will fine SMRT with the maximum amount as such a large financial penalty will most likely impede SMRT’s ability to resolve the root cause and rectify issues to avoid similar incidents. SMRT’s FY15 PATMI is S$91M and the maximum fine represents approximately 71 percent of PATMI.

Accelerating Replacement Work

The root cause for the 7 Jul breakdown was announced to be weak electrical resistance of the third rail insulators. SMRT already has in place a scheduled plan to renew the ageing rail network infrastructure, with the replacement of third rail insulators being one of the planned renewal works.

Having already planned for the replacement of third rail insulators, SMRT will simply be accelerating this replacement process, which is expected to complete by 1QFY17. The direct impact of the breakdown is unlikely to result in a significant increase in repair and maintenance (R&M) expenses, though more R&M works are expected as part of its efforts to improve rail reliability.

Management: Expect Near-Term Weakness

SMRT Management reiterated that the operating landscape remains challenging but is making progress with the authorities on rail reforms. It also guided that the level of 1QFY16 R&M expenses is likely to sustain for the next two to three years as renewal works on the ageing rail system takes place. Staff expenses will continue to increase, mainly on engineers, technicians and bus captains. These higher expenses are expected to continue to be a drag on SMRT’s earnings, at least in the near-term.

Analysts: Long Term Catalysts Intact

Analysts are still positive about the longer-term, as catalysts remain intact. SMRT is expected to benefit from the new bus government contracting model (GCM) and rail financing framework (RFF). SMRT’s bus operations will improve materially on better margin from 2QFY17 onwards under the new GCM. The expected absence of depreciation expenses should help as well.

Recent rail business losses signal that there needs to be a structural change in SMRT’s rail business to make it viable in the long term. While RFF timeline is unclear, it is encouraging to note that progress is being made. A potential 2018 rail reform could raise SMRT’s TP by S$0.71/share.

Si Jie is no stranger to investing having started his journey at a young age. He is heavily influenced by acclaimed investors such as Benjamin Graham, Peter Lynch, and John Rothchild.

Please click here for more information about this author.

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