SMRT Corporation Ltd - Downtown Line setback (OCBC)

Upgrade to BUY

Previous Rating: HOLD

Current Price : S$1.77

Fair Value : S$2.04

Downtown Line operating license awarded to SBS Transit. LTA announced on Monday evening that it awarded the license to operate the Downtown Line (DTL) to SBS Transit over SMRT. The DTL was the first rail line to be put up for competitive tender under the new rail financing framework, which places the ownership of operating assets under LTA to ensure timely replacement and procurement of additional trains. The DTL will be completed in stages with the first to be completed in 2013 (six stations), second in 2015 (12 stations) and the last stage in 2017 (16 stations). The license awarded to SBS Transit for the DTL will be for 15 years (as compared to the existing 30-40 year license period), and will commence upon full completion of the line in 2017.

Setback for SMRT. While revenue yield projections for the DTL are too early to be assessed, at first glance the line still represents decent growth opportunities in terms of rental revenue. The loss of the DTL tender denied SMRT the opportunity to add as much as 14,000 square metres of gross commercial space. Furthermore, the anticipated daily ridership of the line is estimated at more than 500,000 initially, and could potentially increase to more than 700,000 over time.

SMRT looking ahead. Although LTA had dismissed speculation that SMRT's recent security breach had affected its bid, the setback should force SMRT to enhance its operational capabilities and improve its public image, especially since future tenders for the other planned expansion lines could be open to other rail operators. The two lines announced so far are the Thomson and Eastern Region MRT Lines, which are due to built by 2018 and 2020, respectively.

Temporary sell-offs anticipated, buy on weakness. As a recap, for FY12, SMRT is expected to experience cost pressures from higher operating expenses upon full commencement of the Circle Line (CCL) operations from Oct this year as well as increased staff and energy costs. However, SMRT could receive some reprieve from the easing of energy prices going forward. While there is no impact on SMRT's earnings from the loss of the tender, we anticipate some temporary selling pressures following this announcement. We maintain our fair value estimate of S$2.04 and upgrade our rating to BUY, following recent share price weakness, as the stock still represents decent dividend yield (4.4% FY12F). In addition, SMRT operates the main rail blood lines - North-South and East-West lines - and ridership figures have continued to show YoY improvements.