ComfortDelGro - Playing the recovery theme

We remain BUYers of CDG for its strong earnings recovery momentum on lower fuel costs in 2009 and improvement of business conditions and margins in 2010. We maintain our BUY call and raise our target price to S$1.85.

We met with management and received insights into its management of fuel cost, after record high oil prices last year sent margins packing, and plans to reach its self-imposed target of growing overseas contribution to revenue from the near-50% at present to 70% by 2015. We also delved into the impact of foreign currency on its financials and prospects for overseas businesses into 2010.

Playing the recovery theme. We like ComfortDelGro Corporation (CDG) for the two opportunities it offers for playing the recovery theme. The earnings recovery momentum derived from lower fuel expenses is set to continue for the rest of 2009. In 2010, we expect to see improved business conditions on the back of a sturdier global recovery to augment the effect of normalised margins and give earnings a second, and more meaningful, boost.

2009: Margin recovery on lower energy-related costs. Margins are already on the road to recovery on the back of significantly lower oil prices, and the company’s fuel hedging programme that was put in place end-08. In 2Q09, EBIT margin recovered to 12.5% (+5.9ppt yoy), and net margin recovered to 7.6% (+3.8ppt yoy). By our estimation, the bulk of the savings in energy-related costs over 2Q08 flowed directly down to net profit.

2010: Turnover improvements augment effects of normalised margins. CDG is set to enter 2010 with margin levels that no longer reflect distressed business conditions. In addition, we expect some of the circumstances (weak UK earnings, fare reduction in Singapore) that gave rise to weaker turnover to reverse, so that improvements to the top-line augment the effects of normalised margins.

We have changed our valuation methodology from SOTP (DCF for SBST and blended PE for the other businesses) to DCF, as PE valuation is no longer useful for key segments (eg the UK, where transport operators are trading at distressed valuations). Our discounted FCFE places CDG’s value at S$1.85/share (6.4% cost of equity, 2% terminal growth). Our revised target price (up from S$1.76) gives a return of 15.6% over the last closing price of S$1.60.

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