SMRT Corporation Ltd - Will expenses continue to increase for three more years?

2/9/2015 - SMRT Corporation expects operating expenses to increase as it works to improve performance in rail reliability, maintainability, availability, capacity and safety.

Under the current financing framework, asset renewal of the ageing system and an expanded fleet will result in further increases in depreciation.

It is also making progress in its discussions with the authorities on the transition to a new rail financing framework, which would see the government paying for and owning rail assets such as the trains and signalling systems and then leased to operators.

Bus operations are expected to improve compared to FY15.

SMRT Buses will continue to participate in the tenders under the Government’s new bus contracting model.

It will be discussing contract terms for the remaining bus services beyond its licenses expire in August 2016.

However, the outcome of these will not have an impact on the results of the Group for the next twelve months.

DBS Vickers Research downgraded SMRT to FULLY VALUED with a target price of S$1.27, following the earnings announcement.

It says Q1 results were below expectations with profit down 10% YoY despite revenue growing by 7.8%, due to higher staff and repairs & maintenance costs, which more than offset benefits from fare increases and lower energy costs.

Recent train breakdowns add more uncertainty to earnings visibility, it says.

Hence, it cut its forecasts on revised cost assumptions.

CIMB Research has also cut SMRT's target price following weak Q1 numbers that saw costs growing and not abating soon as the transport operator struggles to get its systems in order.

It estimates that SMRT is now worth S$1.42, down from $1.53.

They have maintained a REDUCE call.

The company's Q1 FY16 earnings looked like this:

Revenue: +7.8% to S$320.3 mln
Profit: -10% to S$20.1 mln
Cash flow from operations: S$40.6 mln vs S$34.9 mln

Train and LRT operations suffered a loss of S$3.7 mln and S$1.6 mln respectively, compared to a combined Rail profit of S$4.4 mln in the same quarter a year ago.

Bus operations, on the other hand, recorded an operating profit of S$1.5 mln compared to a loss of S$5.5 mln in Q1 FY15.

Overall, the Group’s Fare business recorded a higher operating loss at S$3.8 mln versus S$1.1 mln.

Operating profit from the Group’s Non-Fare business increased by 5.5% to S$31.5 mln due largely to an increase in profit from Taxi operations and Rental segment.

All said and done, Group operating profit decreased by 5.6% to S$27.7 mln.

Investor Central. Asian insights for global investors. We ask the tough questions of Asian companies which global investors need answers to.

Question

1. Will expenses continue to increase for three more years?

Repairs and maintenance (R&M) costs increased by 19.6% in Q1 due to more trains undergoing scheduled overhaul and a more intensified maintenance regime in Train and LRT operations in view of the ageing systems.

According to OCBC Research, management noted Q1 R&M expenses are likely to sustain for the next two to three years, as renewal works on the ageing rail system takes place.

Staff expenses will continue to increase, mainly on engineers, technicians and bus captains.

This makes us wonder whether SMRT's margin will continue to be impacted for the next three years.

Question

2. When will it be free cash flow positive?

According to the annual report FY15, free cash flow was S$176.5 mln in FY11, S$47.8 mln in FY12 and S$11.9 mln in FY13.

But it burnt S$414.9 mln in FY14 and 183.5 mln in FY15.

Hence, it makes us wonder when SMRT will be able to generate free cash again.

(Read the full story to get all 5 questions)

We have invited the company to an on-camera interview, and/or to reply to our questions in writing.

At the time of publication we have not received a reply (which is why you are seeing this message).

We will update this report if we do.

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