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■ Transport Minister’s speech on 4 Dec hinted again at rail industry restructuring.
■ While capital-unlocking through an asset sale is a positive, market views that the government will grant favourable terms to SMRT are unwarranted.
■ SMRT’s unresolved obligation under the old rail regime represents a key obstacle to obtaining its desired terms in its negotiation with the government.
■ Maintain Reduce. Possible unfavourable terms for the rail sale is a key negative.
Transport Minister hints at potential rail reform
During a forum on infrastructure maintenance on 4 Dec, Transport Minister Khaw Boon Wan talked about the benefits of a rail system that integrated the designer and builder (LTA) and the maintainer and operator (SMRT and SBS Transit). He said LTA needed to be ready to take over rail operations and maintenance when necessary. As a result, SMRT’s share price surged 5.4% during the day, likely due to the market’s belief that the government will take over rail operations and grant favourable terms to SMRT.
Capital-unlocking is good but one should not hope for too much
While we acknowledge that SMRT should benefit from potential capital-unlocking, we doubt if the company will receive favourable terms for the asset transfer. Two issues that must be taken into consideration are the authority’s treatment of SMRT’s asset purchase obligation under the old rail regime and the government’s balancing of public and operator interests. Such issues point to the risk of an undesirable outcome for SMRT.
Hidden liability under the old rail regime is a key obstacle
We deem SMRT’s asset purchase obligation (an off-balance sheet liability) under the old rail regime as a key obstacle to receiving favourable terms. An LTA spokesman said in Jul 14 that the company had an outstanding asset purchase obligation of S$2.0bn between 2014 and 2019 to buy over rail assets from the LTA. We believe the LTA will take these obligations into account when it negotiates with SMRT on the terms for the rail transfer and if it ever extends a new contract to the company in the future.
Is the government’s intention to rescue SMRT’s shareholder?
We believe the reform is purposed to ensure rail reliability, rather than rescue SMRT’s shareholders. Although the elevated repair and maintenance expenses have sent its rail fare business into the red, SMRT’s rail operation as a whole (including transit retail space renting and advertising) has never really been loss-making. In addition, the recent spate of rail disruptions does not help SMRT when negotiating with the LTA.
Positive from asset sale on TP partly offset by a higher WACC
Maintain Reduce. Our new target price of S$1.37, based on FY16 DCF, incorporates a scenario where SMRT transfers S$970m worth of rail operating assets at book value to the government in FY19. The positive impact on valuations from the asset sale will be partly offset by an increase in WACC to 8% from 6.5% previously to reflect the expected change of capital structure (SMRT’s debt will be fully paid off after the asset sale). Key upside risks to our call include SMRT managing to receive a favourable deal. (Read Report)
Source : CIMB Research