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SBS Transit is set for a transformation over the next several years following the award of a licence to operate the Downtown Line, significantly increasing the company’s exposure to the fastest-growing segment of the local public transport system.
The company said last month that it has won the tender to operate the country’s fifth mass rapid transit line for 19 years, which will more than double its share of the local rail network from 40km at present to 82km.
That could shift its revenue profile and lift its profit margins to levels closer to those of SMRT Corp, the other domestic land transport play.
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| SBS could see better margins from its rail operations with the new Downtown Line. |
In FY10, SBS derived 76.2% of its revenue from bus services and just 16.9% from rail, with the remainder coming from outdoor advertising and rentals.
By contrast, in FY11 ended March, SMRT derived 55.3% of its revenue from rail, 22% from buses and 10.2% from rentals and advertising. The remaining revenue came largely from taxis and rail-related consultancy services.
With greater exposure to the Singapore MRT system, SMRT has earned a relatively high net profit margin of 16.6%, versus 7.5% for SBS.
That’s partly because the company earns good margins from renting out retail space within its well-established train stations, and it capitalises on the high traffic going through those stations to sell advertising space.
The rental business generated an operating profit margin of 77.4% in FY11 while advertising had a margin of 67.7%. In comparison, SMRT’s train business managed an operating profit margin of 21.5% in FY11.
Growing rail sector
Now, SBS could soon see greater earnings contributions from these high-margin businesses. In its press release announcing the win, SBS highlighted that unlike the North East Line, which it currently runs and which has limited retail space in its stations, the Downtown Line will have over 14,000 sq m of gross commercial space — more than four times that of the current line.
SBS could also see better margins from its rail operations with the new Downtown Line. In FY10, its rail operations earned a margin of 14.7% on earnings before interest, tax, depreciation and amortisation (Ebitda), about 18.9 percentage points less than SMRT.
This is partly because the North East Line that SBS operates is a shorter and newer line that runs through the less densely populated parts of the island. In July, SBS’s rail operations saw average daily ridership of 502,146, which works out to about 15.6 million for the month. That compares to 55.8 million in total monthly ridership for SMRT’s trains in July.
SBS says that as the Downtown Line “runs through built-up residential and commercial parts of Singapore, ridership growth is expected to be strong.” Once completed, average daily ridership is expected to be in excess of 700,000.
The MRT system is going through a phase of strong expansion, and increasing its share of domestic commuter traffic. CLSA analyst Oliver Campbell, in a report last month, writes that commuters are moving away from bus-only commutes and towards train-only commutes or commutes that involve taking a feeder bus to the train station.
The Land Transport Authority (LTA), in its most recent Land Transport Masterplan, has said it intends to enhance the “hub-and-spoke system” so that the bus and rail services work in partnership.
“There will be more frequent and direct feeder bus services so that commuters can reach the transfer hubs quickly, and enjoy seamless and efficient transfers to the Mass Rapid Transit or trunk buses to continue with their journeys.”
It has already implemented a distance-based fare structure that eliminates penalties from transferring transport modes and is meant to encourage commuters to take the most efficient route.
SBS is already benefiting from this trend of increasing rail ridership. In 2010, ridership on the company’s buses grew 4%, while ridership on its rail services was up 15.9%.
In addition to the North East Line, SBS also operates the Punggol and Sengkang light rail transit (LRT) lines. Ridership on the LRT lines rose 12.2% last year while ridership on the North East Line rose 16.4%. Revenue from bus operations edged up just 0.6% while revenue from rail operations grew by 11.5%.
Will SBS draw analysts’ interest?
Yet, SBS suffers from a distinct lack of analyst coverage at the moment. The company is 75.1%-owned by ComfortDelGro Corp, and its shares are thinly traded. Moreover, it was thought to be less exciting than its parent, which runs the biggest taxi business in Singapore and has transport operations spread across several countries.
In fact, with its steady dividend yield — now topping 4% — SBS has lagged ComfortDelGro by only a small margin. Since ComfortDelGro was listed in 2003, it has returned 11.9% on an annualised basis with dividends reinvested; versus a 10.5% return from SBS.
Neither stock performed anywhere near as well as SMRT, which returned an annualised 21.3% during the same period.
In the years ahead, SBS could offer more potent exposure to the growing MRT network than ComfortDelGro, and perhaps even SMRT. Nomura analyst Lisa Lee expects the Downtown Line contract to begin contributing positively to ComfortDelGro’s earnings only in 2019.
She estimates earnings from the Downtown Line (before interest and taxes) will amount to S$32.6 million (RM80.3 million) in FY19. But that would mean very little for ComfortDelGro, which reported operating profit of S$388.4 million in FY10.
For SBS, on the other hand, which reported operating profit of S$64.7 million in FY10, up just 4%, the increase would be significant.
SBS currently trades at just 12.2 times its FY10 earnings and 1.7 times its book value. In comparison, SMRT has a price-earnings ratio of 17 times and a price-to-book ratio of 3.2 times.
That leaves significant room for its shares to eventually trade at higher multiples as its proportion of rail earnings grows, garnering broader investor following.
Early investors in SBS shares will need to have the stomach for some risk, though.
Andy Sim, an analyst at DBS Vickers, warns that there are several uncertainties ahead for the company as it prepares for the Downtown Line. “In general, earnings may be better. But it is still too early to say for certain,” Sim says.
For one thing, the award of the Downtown Line falls under the new rail financing framework that was put in place by the LTA just last year, Sim points out. Under the new framework, the LTA, instead of the operator, will own the rail operating assets.
SBS will be required to pay an annual licence charge that is estimated to total S$1.6 billion at the end of 19 years. But Sim says there is little clarity as to how this licence charge will be calculated each year.
“Whether or not SBS can improve its margins will depend on the financial metrics for the new Downtown Line. They may not be similar to the metrics for the North East Line or the Circle Line,” Sim says.
Also, while SBS will have significantly more retail space to rent out than it had before, the size of that retail space will likely be only about one-third of the net lettable area that SMRT has in its portfolio, Sim adds.
As at end-March, SMRT had leased out approximately 34,134 sq m of commercial space within its train network. And it continues to develop more retail space at existing stations.
Meanwhile, SBS isn’t exactly brimming with cash. Last year, it issued S$100 million in 1.95% fixed rate notes due 2015. As at end-June, the company was in a net debt position of S$70.9 million, representing a net debt-to-equity ratio of 21.8%. Over the next couple of years, just as its existing North East Line is turning more profitable, early losses from the Downtown Line could begin pressuring its balance sheet again.
On top of that, the LTA has taken on the role of central bus network planner, which will subsequently result in bus routes being parcelled out for tender. That could significantly affect SBS’s bus operation, which is still its core revenue generator.
Much really depends on how quickly SBS manages to build up the ridership on the Downtown Line. It has done a reasonable job with the North East Line. Nomura’s Lee sounds a note of confidence in a report on the company, saying that it has had a good track record in the rail business, having turned its North East Line operation profitable in three years.
Gregory Yap, an analyst at Kim Eng, figures that ridership on the Downtown Line could grow at an aggressive double-digit rate of 10% to 25% in 2018 to 2020.
He also expects rental income to more than double from the current S$10 million a year when the Downtown Line is fully open.
What strategies does SBS have in place? The company declined to be interviewed for this story. Tammy Tan, senior vice-president of corporate communications, says: “In the rail business, as in all our businesses, the strategy is always to grow the top line while keeping a close eye out on the middle line. So, in the case of the North East Line, we have worked at growing ridership while ensuring that costs are kept under control.”
If those strategies are repeatable, SBS could be on its way to becoming a much more exciting company in the years ahead. — The Edge Singapore
