SMRT - Inside track for incessant growth

Key beneficiary of Singapore's LT Master Plan. We believe SMRT, as one of the key public transport operators in Singapore, is well primed for the opportunities created by the Land Transport (LT) Master Plan. Under this new road map, Singapore will see sweeping changes to its entire spectrum of transportation services in the coming years. As it is part of the Land Transport Authority's (LTA) main strategic thrusts to make public transport a choice mode of transport for its population, and rail network the backbone of Singapore's public transport system, we believe SMRT is likely to benefit from the better connectivity and stronger ridership.

Likely to maintain 60% dividend payout ratio. We also see a strong case in SMRT's ability to uphold its profitability and dividend payout going forward. By looking at the time-series trend analysis of its operating costs breakdown, we observe that the electricity and diesel costs have been growing at an accelerated pace over the years, thereby contributing to a larger percentage of the costs. However, with the US real GDP projected to decline by 2.8% in 2009 and the global real GDP to fall by 0.8%, according to EIA, this is likely to keep the domestic consumption for all major fuels and their accompanying prices at low levels. Therefore, while we acknowledge that SMRT is likely to be burdened by higher labour costs following the commencement of the Circle Line, a higher expected ridership, coupled with lower percentage electricity and diesel costs, are likely to enable the group to uphold its profitability and dividend payout.

Initiating with BUY. We like SMRT for its defensive nature, consistently strong dividend payouts and strong operating cash flows. While the group is currently trading at a 18.8% premium to its Singapore-listed land transport peers' current PER, we feel that it is undemanding given its superior earnings margin of 18.7%, ROE of 22.8% and dividend yield of 5.0%. For FY08-12, we expect the group to register an EPS CAGR of 6.6%, thanks to a continued increase in ridership, higher rental and advertising revenue and expanded engineering services. We initiate coverage on SMRT with a BUY rating and S$1.83 fair value, based on two-stage Dividend Discount Model (DDM) valuation methodology. Our fair value implies a 17.3% upside potential and at 16.9x FY10F EPS, which is still slightly lower than 17.4x average PER seen in 2008. Key risks include exposure to volatile energy costs and compliance to performance standards set in its License & Operating Agreement.

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