SMRT Corporation Ltd: Challenging times ahead

4Q revenue growth likely to be offset by higher operating expenses. 4Q revenue growth looks likely to be supported by increases in MRT and bus ridership of about 11.8% and 6.6% respectively for the first two months of the year over the same period last year. However, with lower average fares resulting from the implementation of distance fares and the increase of wholesale electricity prices during the first three months of the year (Exhibit 1), we expect a squeeze on 4Q operating profits. Furthermore, staff and related costs are expected to increase due to new staff recruitments for stages 4 and 5 on the Circle Line. Repair and maintenance expenses are also expected to rise in 4Q.

Challenging operating environment ahead. As SMRT enters FY2012, we expect cost pressures to persist with revenue growth being unable to keep pace with operating expenses. We anticipate continued operating losses from the Circle Line due to lower-than-expected ridership and higher staff costs due to increased employment from stages 4 and 5. Even with the impending completion and full operation of the Circle Line in end 2011, we foresee only a marginally increase in ridership and revenue contribution due to the implementation of distance fares. Higher electricity and diesel costs are also expected to remain elevated at least in the next two quarters ahead as geopolitical concerns in MENA exert upward pressures on crude oil prices. In terms of revenue growth, fare hikes seem unlikely this year even with increases in the consumer price index and average wages, which are the two main components in the fare adjustment formula. Given the general sensitivity of the population towards price increases, especially in an election year, we believe that any fare hike will only take place towards the end of the year. However, potentially higher revenue resulting from the rental of its commercial properties and advertising spaces may help SMRT to cushion some of the cost increases.

No near-term price catalyst; valuations under review. Since our last update on 31 Jan 2011, SMRT's share price has dropped about 7.9% to its current level of S$1.89. We believe that the decline reflects the pricing in of the above mentioned factors. However, there has been some price consolidation over the past few days as investors await the release of full year FY2011 results. In view of this and due to a change in analyst coverage, we are reviewing our previous HOLD rating and fair value estimate of S$2.16.

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