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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ComfortDelGro: Lower energy costs boosted margins

2Q09 results in-line with expectations. ComfortDelGro registered 2Q09 PATMI of SGD57.3m, up 0.9% YoY (+9.1% QoQ). 1H09 PATMI of S$109.8m was 49.3% of our full year forecast of S$222.8m (consensus S$219.4m). Revenue fell by 4.0% YoY to S$758.3m due to the negative translation effect of the weaker £ and A$. Excluding the translation effect, revenue would have risen by 0.3% to S$792.5m. Operating profit surged 81.7% YoY to S$94.5m due largely to a sharp fall in operating expenses led chiefly by a drop in fuel and electricity costs. Maintain BUY with a DCF-derived target price of S$1.78, based on a 6.9% WACC and 3% terminal growth rate.

Lower energy costs boosted bus earnings. Revenue from the group's bus operations fell by 3.9% as growth from operations in Australia and China was offset by declines in Singapore and the UK. The temporary fare reduction, increase in transfer rebate and decline in bus ridership (-2.1%) led to a 7.3% decline in Singapore bus revenue. This was, however, offset by lower fuel prices which led to the surge in EBIT from S$3.1m in 2Q08 to S$10.7m.

Weak rail ridership seen in Jan-Jun. In 1H09, ComfortDelGro daily Singapore rail ridership rose 6.6% YoY to 0.36m, slower than 2008's growth of 15.4%. We are, however, upbeat that ridership figures could be stronger next year on the back of stronger economic and tourism growth. We expect NEL to see stronger ridership when RWS opens its doors in 1Q10.

Underperformed broader market despite healthy earnings. Since March, ComfortDelGro's stock price rose 22% vis-à-vis the STI's 76%. We believe the underperformance is unjustifiable given its stable earnings growth. An interim dividend of 2.63¢ was declared, representing a payout ratio of 50%. ComfortDelGro currently trades at 14.6x FY10 P/E multiple which is at the mid range of its 13-17x trading band. At our target price of S$1.78, ComfortDelGro will trade at an FY10 P/E multiple of 16.5x. We, however, prefer SMRT as it remains a key beneficiary to Singapore's land transport structural growth story.

Maintain Buy on ComfortDelgo with Target Price of S$1.75

1) Central planning has been delayed as the government is having consultations at the grass roots level. LTA could start to amend the bus routes in 2H09 but has not revealed plans as to how the bus industry will be deregulated.

2) CD expects its bus routes to be unaffected by the opening of Circle Line. Bidding for Downtown line has been postponed till next year and mgmt believes that they stand a good chance of winning given their prior experience operating a driverless system.

3) Question on the 41% YoY jump in insurance costs in the 1Q09. Mgmt replied that this was due to a change in the formula of calculating its insurance from burning cost (back-end loaded) to a fixed cost formula in 2009. On an annualized basis, CD's cost of insurance would only have increased by 3.7% YoY.

4) CD has kept its hedge on its diesel and electricity costs at 50% in FY09E at an average cost that is 30% lower than the actual cost in 2008 (average price of oil was US$99/bbl in 2008).

5) Overseas operations continue to see growth. CD can benefit from long-dated fixed operating bus contracts in Australia and UK. Bus and taxi operations in China continue to perform well. However, its taxi call centre in the UK has been affected.

Maintain Buy on CD with TP of S$1.75. We remain comfortable with our earnings forecast as the company can continue to benefit from resilient ridership, moderating costs and higher overseas contribution. The stock has been an underperformer and is trading at a 25% discount to the market PE, below its long term average which is at a 22% premium to the market. We expect the stock to outperform the market if there is a pullback.

ComfortDelGro - Sell: 1Q09 Profit S$52.5m (4Q: S$44.8m)

Results inline — Group revenue fell 6%qoq to S$717m (non-fuel -4%qoq) offset by lower staff and fuel expenditure to deliver net profit of S$52.5m, (+4.6%yoy, +17%qoq) and c.24% of Citi and consensus FY09 estimates. The stock has underperformed the index in the recent rally (+1% vs +46% for STI since March) and will likely continue so if the STI moves towards our 2,400 target. Maintain Sell.

Bus — Bus revenue down 4%qoq to S$354m (4Q: S$369m). By geography, Singapore revenue slipped slightly by 0.8%qoq while UK fell by 10%qoq to S$131m (weaker GBP). Australia grew by 12%qoq following acquisition of Victoria business in Feb-09. Benefiting from lower fuel and manpower costs, operating profit rose by S$8.5m to S$29.6m, with 48% sourced from overseas.

Rail — Revenue rose slightly by 1.4%qoq as operating profit dropped to S$5.3m (4Q: S$6.1m). Recent ridership trends suggest a moderating of the strong, double-digit growth seen in early 2008 (Mar 2009 +7.8%yoy).  Taxi — 1Q op. profit was S$24.3m (-11%yoy, -2.8%qoq). Singapore revenue S$152m (4Q: S$162m) while overseas revenue fell to S$73m (4Q S$77m) with weaker UK performance partly offset by better results in China.

Diesel sales — 1Q profit was S$4.5m (4Q: S$5.8m) as 1Q avg spot diesel fell to US$57/bbl (4Q: US$76/bbl). 1Q09 QTD diesel cost was US$60/bbl, suggesting that profit on diesel sales (partly offset by diesel hedging losses) could continue assuming prices stay at these lower levels.

ComfortDelgro - Maintain HOLD, and fair value estimate of S$1.37

ComfortDelGro Corp announced their first quarter results ended 31 March 2009. Group revenue fell by 4.4% from S$749.6 mil in 1Q08 to S$716.6 mil for 1Q09 due to a negative translation from a weaker Sterling Pound and Australian Dollar of S$50.1 mil. Without this translation loss, revenue would have risen by 2.3% to S$766.7 mil. Operating expenses declined 5.7% from S$673.4 mil in 1Q08 to S$635.1 mil due mainly to receipt of the Jobs Credit in Singapore, decrease in the cost of diesel purchased for resale to the Group’s taxi drivers and a reduction in fuel and electricity costs. The Group’s operating profit increased by 7.0% or S$5.3 mil from S$76.2 mil in 1Q08 to S$81.5 mil for 1Q09. Operating profit would have been higher at S$84.7 mil if not for the negative foreign currency translation of S$3.2 mil.

Business segment review. Bus business at Group level decreased by 8.6% to S$347.9 mil where the adverse impact of the decline in the Sterling Pound and Australian Dollar more than offset the gains in revenue from these two countries. The China bus business did continue to grow in revenue and ridership coupled with a stronger Renminbi leading to a translation gain of S$1.6 million. Singapore’s bus business saw a decline of 0.4% to S$142.2 mil as average daily bus ridership fell marginally by 0.3%.

Taxi. Although the taxi business in Singapore and China did increase, it was insufficient to mitigate the decline in the Group’s UK taxi business leading to an overall decline of 2.3% to S$225.4 mil. Due to the economic downturn, the Group saw a drop in corporate bookings of S$8.7 million leading to revenue from the UK taxi business decreasing by 33.6% to S$38.1 mil.

Rail. The rail business saw average daily ridership for both the North East Line and the LRTs increasing by 8.3% and 7.6% respectively. Revenue from rail increased 10.5% toS$27.4 million. Including rental and advertising income, total revenue from the rail business grew by 12.0% toS$29.9 million for 1Q09. Vehicle Inspection and Testing Services. This segment saw growth of 9.6% to S$19.6 million mainly from an increase in the number of vehicles inspected as well as an increase in the number of projects completed by Setsco Services Pte Ltd. Bus Station. The bus station business under Guangzhou Xin Tian Wei increased by 15.4% to S$6.0 mil for the quarter due to a rise in the number of passengers using the station.

Maintain HOLD, and fair value estimate of S$1.37. ComfortDelgro Corp is currently operating in a challenging environment. We expect its UK bus and especially the taxi business segment to continue its downward trend. Bus operations in Singapore might also be affected given the fare reduction exercise and the increase in transfer rebate. As mentioned in our initiation report, we will continue to watch the unfolding of 1) centralized bus planning, 2) bidding for rights to operate the Downtown Line, and 3) further information on CD’s growth strategy in China and Australia to determine the ongoing validity of our valuation and recommendation.

ComfortDelgro: 1Q09 revenue would have expanded if not for negative currency translation

ComfortDelgro reported 1Q09 net profit of S$52.5m, up 4.6% YoY, in line with our expectations. Revenue contraction due to negative currency translation effect. Revenue contracted 4.4% YoY to S$716.6m. If we strip out the negative translation effect of the GBP and A$ of S$50.1m, revenue would have risen 2.3% YoY. Overseas revenue accounted for 40.3% of total revenue, versus 44.5% in 1Q08.

Australia bus operating profit up due to recent acquisition. Singapore bus revenue contracted 0.4% YoY due to a 0.3% YoY fall in 1Q09 average daily ridership. However, operating profit from this segment was up 6% YoY due to lower fuel costs. Whilst London bus revenue and operating profit were down due to the weaker GBP, Australia bus operating profit was up 11% YoY due to the acquisition of CDC Victoria since its 23 Feb 09 acquisition.

Operating profit of S$81.5m was 7% higher YoY. Stripping out the negative foreign currency translation, operating profit would have been 11.2% higher. Taxi revenue was down 2% YoY due to weakness for the UK taxi business, but partly offset by increases in the Singapore and China taxi businesses. But taxi operating profit was down 11% YoY.

Whilst the Singapore bus fare reduction effective 1 Apr 09 will lower Singapore bus revenue, we expect Australia bus revenue growth and YoY declines in fuel costs to contribute to overall net profit growth. We are assuming FY09 average crude oil price of US$59/bbl, versus FY08’s US$105/bbl. After factoring in the hedges made by ComfortDelgro, we forecast a 37% decline in FY09 fuel costs. The weakening of the GBP and the A$ started in Sep/Oct 08 and hence the negative currency translation effect should diminish by 4Q09.

Our S$1.78 target price is derived from sum-of-the-parts valuation. Share price catalysts include our forecast 32% recurring net profit increase for FY09, and an attractive FY09 dividend yield of 4.7% (based on a 55% payout ratio).