Riding Along The North-South Line

Disclaimer:

• The  following analysis is purely my personal opinion. I urge you to do your own assessment and calculation for any relevant decision making purposes.

• The analysis is  based purely on consideration of the company's  financial and economic interest.

Introduction

In this report, I will first describe SMRT's business model,  identify the mistakes made by  SMRT, improvements that can be made. Finally I will attempt to predict  its possible  price movement  under  2 scenarios.

Business Model And General Strategy

SMRT's business model is much like telecom companies such as Singtel. These comapanies spent huge amount of upfront captial to lay the telephone lines (for  Singtel)  and train track (for SMRT), these  expenses then become fixed cost and sunk cost. After setting up the basic infrastructure, these companies can make a profit so long as they provide their service at a price higher than the variable per customer. The difference between Singtel and SMRT models being that Singtel incur negligible varible for serving each additional customer, while SMRT incur a slight higher variable cost for each additional (group of) customers served. This is due to the expensive fuel cost. Nevertheless, I would like to emphasize that  SMRT business model is definitely viable, this is especially true as the firm has near monopoly advanatage. The " inelastic demand" advantage is not mentioned here as SMRT  is not free to  raise its price to use this advantage.

The general stratgey for such business model would be to (1) cut variable cost and (2) increase  revenue (refering to customer volume  not fare  price).   

Going Down The Wrong Track (SMRT's Deadly Mistakes)

Instead of following the general strategy, SMRT decided to do just the exact opposite- (1) increase variable cost and (2) decrease utilisation of the train track.

1. Decrease Variable Cost
• Control the staff cost:
• This can be done by doing sampling check on train rather than having a few staffs standing and ideling on each train.
• Other than those staff  who carry weapons, staffs on board  should   wear plain civilian clothes rather than flashy green uniform. This is a stronger  deterrence for  the passengers with any unscrupulous motive since the passengers  have no idea who  are the staffs on board, where are they coming from and how many of them are on board. Thus it achieve a  stronger effect with less people. In constrast, under the old system unscrupulous passengers are only deterred when a staff is in sight. Hence the old system need  to increase the number of  staffs as passengers increase, which is inefficient and expensive.
• Redesign the train:
• Invest in designing train carriages that can be detached and attached easily. This allows better response to traffic  demand. E.g. Running a 2 carriages train  instead of a standard 6 carriages train during non peak hours. This not only allow huge saving from  fuel cost, and  wear and tear but also improve the frequency of train service- one 6 carriages train converted into three 2 carriages train. Thus improved quality of customer service.   
• Strategic Alliance (SA) For Alternative Fuel
• Although fuel cost take up a sizable percentage of the firm cost, I am surprised to see that the company has not taken any significant step to explore alternative fuel. Instead of maintianing the high annual dividend payout, hoping investors to remain confident in it, SMRT could have invest the cash in a SA with other transportation comapnies (e.g. SIA)  to search for alternative fuel. This should give sizable profit in the long run. The management  should be  expected  to be more proactive in taking up such initiative, this is especially true as SMRT management has little worry about competition.
2. Increase Revenue
• Remaping Bus Routes (I am not sure about the feasibility of this, can someone shed some light on this one?)
• The  train  network is quite well developed in Singapore, granting access  in all directions. How about using the train network as a backbone to travel between towns and limit bus services to intra-town only? Other than that, buses should only be travelling on routes where using the train does not make economic sense e.g. Pasiris to Punggol. If this idea is feasible, it would increase  utilisation  of the train network and improve  its bottom line GREATLY- as the high fixed cost magnify the impact of higher revenue on profit.

Scenario 1: Riding Southward

This is the case where SMRT will keep its status quo and make no significant changes. In my own opinion, this is the likely case for the next 5 years. The current CEO who has taken leadership for about a year has not made much strategic changes other than  making repair here and there.  The management group also appeared to be at  its wit end when it cried for a " More Sustainable Business Model" . Under this scenario, we can expect SMRT's profit to continue nosediving as the huge amount of wastage it is currently running would be further magnify as population continue to increase. Investors also have to mindful that SMRT is a defensive counter  which tends to be overvalued during economic downturn and tends to be undervalued when economic is blooming. Under the assumption that economic will progressively recovered from June 2013 onwards, I have assigned a TP of 76cents to SMRT. That being said,  investors should  not expect to see SMRT share price free falling.  This is because the high dividend payout continues to deter short-sellers. Thus the  falling of SMRT share price will more likely to be a slow and  painful  death.

Scenario 2:   Hope Of Riding Northward

This is the case where SMRT starts to implement major changes (such as  those pointed out in the reccomendation)  based upon  the general strategy of reducing variable cost and increasing utilisation of its train services. However, the possibility of this happening is low and I do not expect this to be the case till there is a change in CEO. The current CEO continues to think that the problem lies within the tunnel and with its people. He probably wasn't aware that it is the high  staff (variable) cost that is unsustainable not the business model, while  frequent maintance and use of higher quality  claws are highly  affordable so long as the business  remain  profitable. 

Anyway should this scenario happened, I would give SMRT a TP of 93cents. Nevertheless, this TP is still a long way from the current price. The huge  discount reflects the high risk of  making such a huge strategic changes- this is especially necessary for SMRT as its management has got little experience of initiating changes.

Just sharing my view here, email me [email protected] if you have something to share with me. Thanks.

Author: Rosesyrup

Staff cost rose 23.4% to $112.7 million due to increased headcount for train

and bus operations and wage revision, partially offset by the Wage Credit Scheme.

Very jialuck!

How do we view this?

Investment Actions?

The previously unimaginable has happened. SMRT is expecting its first ever quarterly loss in its history for 4QFY3/13. Escalating operating costs and a SGD17m impairment in goodwill in its associate, Shenzhen ZONA, are the primary causes of the loss. We are expecting the PATMI loss to come in at ~SGD2m for the quarter, which still points to profitability at a core level excluding the effects of the impairment.However we expect final dividends to be cut as a result of this announcement. We were among the earliest to downgrade SMRT to a SELL in early 2012. This loss guidance validates our sustained SELL call, and we are reiterating it with a reduced, Street-low target price of SGD1.19.