LAND TRANSPORT - Opera tors seek fare increase of up to 2.8% (DMG)

SBS Transit and SMRT have both applied for fare hike of 2.8%, in accordance to the maximum fare adjustment formula set by the governmentappointed Fare Review Mechanism Committee (FRMC) in 2005. Results of the application will most likely be announced in 4Q11 by the Public Transport Council (PTC). Given SMRT’s earnings are predominantly driven by Singapore’s train service (accounted for 58% of FY11 EBIT), it will experience the most impact compared to ComfortDelGro (CD). Our sensitivity analysis shows that a fare hike of 2.8% could raise SMRT’s and CD’s net profit by 11% and 6.6% respectively. Maintain OVERWEIGHT on the sector on the back of 1) resilient growth in ridership number, 2) potential fare hike, and 3) imminent award of Downtown Line in 2H11.

Maximum fare adjustment formula is tied to CPI, WPI and productivity gains. In order to cap overall fare increases in small, regular steps, the land transport operators are allowed to apply for fare adjustments according to FRMC-stipulated formula. Besides taking into consideration of the maximum fare adjustment request put forth by operators, the PTC also takes into consideration of other factors such as profitability of the two transport companies, as well as Singapore’s economic condition. This is evident from the fare adjustments carried out in 2008-2009 (2008: +0.7% fare hike; 2009: -4.6% fare hike) vs maximum allowable adjustments of +3%-+4.8% respectively. Our current estimates for both SMRT and CD are based on ~0.5% hike in fare prices of Singapore’s MRT and bus services.

Prefer CD within the sector. We continue to favour CD (BUY/TP S$1.80) over SMRT (NEUTRAL/TP S$1.94) due to the former’s 1) greater overseas growth potential, and 2) cheaper valuation. In addition to margin improvements from ridership increase, we think CD will be looking at acquisition of more land transport companies in foreign markets in order to achieve overseas growth. Separately, previous concerns regarding CD’s forex exposure due to its extensive overseas operations in UK & Ireland (9M10: 13% CD’s EBIT), Australia (9M10: 16% CD’s EBIT), and China (9M10: 12% CD’s EBIT) is overblown, evidenced from the minute forex impact on CD’s results in the last three quarters. Given the approximately even contributions from the emerging (China) and developed nations (UK, Ireland, Australia), we reckon the chances of adverse forex movement from sustained strengthening of S$ against the local currencies of CD’s overseas operations as low.