Land Transport

Margins under pressure due to volatile oil prices; improving ridership to cushion impact of oil price hikes

Spiralling oil prices expose Singapore’s two main land transport operators, ComfortDelgro Corporation (CD) and SMRT Corporation (SMRT), to margin pressure as they have limited ability to pass on costs. That said, we expect improving ridership to partly offset the negative impact of volatile oil prices.

CD, which has a 75% stake in SBS Transit(SBST) and overseas bus operations, is more sensitive to oil price changes while SMRT will benefit more from ridership growth or fare adjustments. We estimate a 1% ridership/fare improvement could roughly offset the impact of US$5.90 and US$2.10 increases in oil prices for CD and SMRT respectively. We prefer SMRT to CD amid the current uncertainties.

Earnings not so defensive against oil prices. Spiralling oil prices expose land transport operators like CD and SMRT to margin pressure. Both companies currently do not hedge against oil prices and thus are exposed to oil prices volatilities.

Direct energy costs formed 9.4% and 13.0% of CD’s and SMRT’s total operating cost in 4QFY08 and 1QFY08 respectively, up from 7.3% and 12.1% one year ago. CD's energy costs increased more quickly partly due to its larger bus fleet. In addition, both CD and SMRT need to sell diesel to taxi drivers at subsidised prices to retain taxi drivers and maintain taxi hire-out rates. CD incurred an operating loss of S$6.3m in 1QFY08, an amount equivalent to 8.4% of total operating profit, compared with a profit of S$6.4m one year ago.
Limited ability to pass on costs. As public transport operators, CD and SMRT have limited ability to pass on costs. The annual bus and rail fare adjustment is subject to Public Transport Council’s (PTC) approval. The fare adjustment formula, based on inflation, earnings and productivity, determines the cap for the adjustment, which we estimate at 3.9% for 2008.

In view of the inflationary environment and regulatory constraints, our fare adjustment assumption is lower than the cap allowed by the formula. We assume 1.0% and 1.8% adjustments for rail and bus fares respectively, to be approved in 2H08.

Improving ridership is a positive. We saw significant ridership increases for both rail and bus ridership in Jan-May 08. This could be partly attributable to the switch to public transport after the taxi fare hikes in Dec 07. Rising petrol prices are another push factor, as evidenced by the sharp ridership increase in Apr-May 08 in the wake of runaway oil prices since March.

The Singapore government’s push for public transport usage – eg by raising Electronic Road Pricing (ERP) rates and installing more gantries – is also a long-term drive to boost public transport ridership. This would improve CD’s and SMRT’s yields significantly due to their high operating leverage.
CD is more sensitive to oil price changes due to its larger taxi and bus fleet. We are assuming full-year oil prices of US$115/bbl. Buses contributed 39% of CD’s operating profit in 1QFY08, vs SMRT’s 0.4% in 4QFY08. We estimate a US$10 increase in oil prices would drag down CD’s profit by about 12.5%, vs SMRT’s 6.1% in the same event.
SMRT could withstand oil shocks slightly better. It has locked in electricity prices for rail until Oct 08, which accounted for half of its energy costs in FY08. We believe it could negotiate good rates for future contracts due to its strong market position. In addition, SMRT’s rental income, accounting for 22% of total operating profit in 4QFY08, could cushion it against oil price shocks.

SMRT Corporation (SMRT)
BUY
Current Price: S$1.80 Target Price: S$1.98

ComfortDelgro Corporation(CD SP)
HOLD
Current Price: S$1.62 Fair Price: S$1.80

SMRT would benefit more from ridership growth or fare adjustments,thanks to its higher operating leverage. CD’s overseas bus revenues (including the UK and Australian markets) are based on contract rates plus performance bonus rather than fare income. Therefore, CD would benefit less from ridership improvements. In the event of a 1% ridership/fare adjustment in Singapore from our base scenario, SMRT’s bottom line would be enhanced by 3.6%, higher than CD’s 2.7% rise.

In other words, a 1% ridership/fare adjustment can roughly offset the impact of US$5.90/bbl and US$2.10/bbl oil price increases for SMRT and CD respectively.

Note: SMRT’s financial year ends on 31 March.