SINGAPORE (May 20): SBS Transit’s share price is up some 51% this year alone, but despite the surge, the downside may be limited. Here’s why.
On May 13, SBS Transit announced a 6.9% y-o-y rise in revenue to $350.8 million for 1QFY2019 and a 27.7% increase in operating profit to $26.3 million. After accounting for a 5.5% hike in operating costs, operating profit margins are 7.5% compared with 6.3% for the same period last year. Net profit rose 28.8% y-o-y to $25.4 million after accounting for finance costs and investment income.
Operating margins have been increasing since 2014 (see Table 1), with the biggest gain from FY2017 to FY2018. The rise in margins is attributed to a fully operational Downtown Line (DTL) for a full year, the rise in ridership on the North East Line (NEL) and the bus contracting model (BCM), which came into operation from 3QFY2016.
SBS Transit is fortunate in that it operates two main modern MRT lines — NEL, which brings commuters from the increasingly densely populated Sengkang and Punggol areas into town; and DTL, which stretches from Bukit Panjang in the north to Expo in the east by criss-crossing Marina Bay and the old CBD near Raffles Place.
In FY2018, SBS Transit’s rail segment made close to 428 million passenger trips, or a 20.2% increase over FY2017. With all its 34 stations opened for passenger service, average daily ridership on the DTL soared from 279,116 in 2017 to 449,588 in 2018, an increase of 61.1%. In 1QFY2019, average daily ridership for the DTL grew 10.4% y-o-y to 476,000 passenger trips a day.
To be sure, NEL ridership has also been gradually rising, but at a slower pace. Daily ridership rose 2.7% y-o-y in FY2018 to 591,203, and for 1QFY2019, average daily ridership grew 3.2% y-o-y to 603,000 passenger trips. SBS Transit also operates the Sengkang-Punggol LRT (SPLRT), which saw average daily ridership increase by 8.9% y-o-y to 131,583. For 1QFY2019, average daily ridership stood at 141,000, up 10.4% y-o-y compared with 1QFY2018.
Despite the sterling performance — DTL clocked 928,000 train-km, a significant improvement compared with the 650,000 train-km recorded in 2017 — and its share price performance over the past five years, SBS Transit is not seen as a growth stock. This is because as a rail and bus operator, public transport prices are controlled. Moreover, for rail operations, earnings before interest and tax (Ebit) are also controlled.
Ebit has limited upside and downside
FY2019 will be SBS Transit’s first full year with both NEL and DTL operating under the New Rail Financing Framework (NRFF). NEL and SPLRT started on the NRFF on April 1, 2018, and SBS Transit has been granted a 15-year licence to operate the lines until March 31, 2033.
DTL’s licence is for a period of 19 years starting Dec 19, 2013. The licence fee was not announced, but SBS Transit pays the Land Transport Authority a cash-bid amount if the net operating surplus for a financial year is more than the threshold profit. This comprises a fixed charge and a revenue share under the Fare Revenue Shortfall Sharing scheme (FRSS).
The NRFF is an asset-light model that relieves SBS Transit of heavy capital expenditure for the trains. Under the NRFF, LTA will own and pay for the operating assets, including additions, renewals and replacements. In February last year, SBS Transit sold its operating assets (trains) to LTA for $29.21 million.
The FRSS mechanism offers some level of protection against revenue risks arising from uncertainties in ridership and fares. “Under this mechanism, if the actual revenue falls short of the target revenue by 2% to 6%, LTA will share 50% of the shortfall. If the shortfall between the actual revenue and the target revenue exceeds 6%, LTA will bear 75% of the incremental revenue shortfall beyond 6%,” the company states.
Under the profit share FRSS model, LTA and SBS Transit also adopt an Ebit cap and collar mechanism, that is, Ebit is capped at a certain level and is supported (the collar) at a certain level. LTA shares in the upside of the Ebit above the cap as well as the downside risks below the collar.
If the Ebit margin is lower than 3.5%, LTA will share 50% of the shortfall. If the Ebit margin exceeds the cap of 5%, the excess will be shared via a tiered structure, whereby 85% to 95% of the incremental Ebit above the 5% cap will be shared with LTA. LTA’s sharing under the FRSS scheme and the Ebit cap/collar is limited by the amount of licence fee payable by the company for the year.
In addition, the LTA may reimburse or be reimbursed by the company when new regulatory changes initiated by the former after the transition lead to changes in operating costs or revenue. Regulatory changes that may impact operating costs or revenue include modifications to operating performance standards for the rail lines, maintenance performance standards for the operating assets (trains), key performance indicators or codes of practice and changes in rentable and advertising spaces available for generating non-fare revenue.
Stable earnings from bus contracting model
The company no longer breaks down its revenue from bus and rail following the move to BCM in 2016. In FY2015, bus revenue was $810.3 million when the company had a bus fleet of 3,656 and an average daily ridership of 2.83 million. Rail revenue was $213.4 million when average ridership on DTL was just 76,000.
Now, SBS Transit has two divisions: public transport, which reported revenue of $334.4 million for 1QFY2019, up 6.8% y-o-y; and other commercial services (such as revenue from advertisements), which chalked up revenue of $16.3 million, up 9.6% y-o-y.
Under BCM, SBS Transit bids for bus packages and is contracted and paid by LTA to operate public bus services through a competitive tendering process while LTA retains the fare revenue. The company’s operating profit stream depends on how it manages costs. Operating costs rose 5.5% in 1QFY2019, but the company still managed to increase operating margins. Like all business models, economies of scale help in keeping costs contained.
SBS Transit operates nine bus packages (see Table 2), which appear to form the largest part of its revenue and earnings. SBS Transit chairman Lim Jit Poh hints in the 2018 annual report that train revenue is sub-par: “Although the financial performance of our rail services continued to be weak, operationally our rail services continued to perform well.”
In March 2018, SBS Transit rolled out its Seletar Bus Package, which was awarded in 2017. It comprised 26 bus services, of which 12 used to be under another operator. “As part of this bus package, we took over the operation of the new Seletar Bus Depot, a purpose-built facility that can house up to 530 buses in an area of 96,000 sq m,” Lim says.
In November last year, the company successfully tendered for the Bukit Merah Bus Package with 18 services. As part of this package, SBS Transit took over the newly built Ulu Pandan Bus Depot. With the Bukit Merah package, the company operates seven bus depots, one bus park, 17 bus interchanges and 14 bus terminals.
As the provision of bus services now comes under BCM, any fare revision implemented by the Public Transport Council will have an effect only on rail revenue. Transport fares, as announced by PTC, increased 4.3% from Dec 31, 2018. The new formula made revisions to the wage and price index weightages and productivity extract, and introduced a new network capacity factor component to track capacity provision in relation to passenger demands.
Sound dividend strategy but fully valued
Based on the past five years (see Chart 1), SBS Transit has a 50% dividend payout ratio. Between 2014 and 2018, dividends per share have risen almost six times. The steadily rising earnings during this period have caused the company’s share price to rise and its dividend yield currently stands at 3.27% (see chart in sidebar). While this is comparable to the yields of the bonds of other public transport players, the share price is somewhat overvalued. In Chart 2, which shows the standard deviation of price to net asset value, the current valuation is at an extreme high. NAV is $1.64, and price-to-NAV is more than 2.4 times, compared with the mean of 1.75 times.
But, just as investors flock to comparative plays when companies are privatised (the privatisation of Keppel Land benefited mid-cap property players such as UOL Group), SMRT’s privatisation in 2016 has probably put a floor under SBS Transit’s share price and valuation. With no other stable proxy for defensive domestic demand (the population has to travel to work and for leisure), SBS Transit may remain overvalued for months, maybe years.
Stable bond returns versus dividend growth
The chart shows the yields from the two different asset classes: equity and bonds. Equity is represented by SBS Transit, while bonds are represented by the Land Transport Authority and SMRT. The key point to note is that this is the return an investor obtains annually from dividends (for equity) or from coupon payments (for bonds); and this return ought to be higher than the risk-free rate, represented by the 10-year Singapore Government bond yield, for the investment to be attractive. -- Thiveyen Kathirrasan
