Action: Maintain reduce on ComfortDelGro; UK bus woes set to rise

We maintain our Reduce rating and SGD1.98 TP (based on 13x FY18F EPS and implying ~9% potential downside) on CDG given the stock trades at 14.6x FY17F P/E despite a FY16-19F earnings CAGR of only 3% (consensus estimate). Go-Ahead (GOG), CDG’s competitor in the London bus business, reported results last week and guided a tough outlook for the London bus business. We discuss GOG’s results and other headwinds faced by the London bus business in this note. We estimate the UK bus business (mainly London) contributes ~20% of group operating profits.

CDG’s key competitors cite challenging outlook

Both GOG and StageCoach (SC), CDG’s competitors in the London bus business, have guided overall challenging market conditions. While GOG reported flat FY17 (year-end June) operating profit, London bus mileage declined 1.7% y-y (FY16: +2.3%). Also, while Quality Incentive Contract (QIC) bonuses rose y-y, they remained below historical levels, and the group has guided that bonus payments will likely be flat in FY18. Overall, GOG guided slightly weaker performance in FY18F on a y-y basis for London bus.

Multiple headwinds for London bus business in 2018-19

CDG’s subsidiary Metroline Ltd is the second-largest bus operator (19% of scheduled bus mileage) in London, with a fleet of over 1,740 buses, plying routes mainly in North, West, Central London and Hertfordshire. We see three key headwinds for the London bus business over the next two years: 1) cannibalisation from higher rail capacity in Central London (Elizabeth line start up: late-2018), 2) slower bus demand due to lower traffic speeds, and 3) higher competition resulting in lower pricing and the risk of potential contract losses.

Elizabeth line start-up in 2018 to impact bus demand negatively

Over the past five years, buses have lost market share to rail. As the Elizabeth line, which adds ~10% to Central London rail capacity, opens in end-2018 (and subsequent phases in 2019), we expect bus demand to weaken further.

Declining bus journeys may lead to lower work-scope on renewal

Bus journeys in London have already been declining over the past 2-3 years (FY16: -3%, FY17: -2%) and are down 1.5% ytd in FY18 (March year-end) – this is mainly attributable to slower traffic speeds on account of congestion issues. As per the latest outlook by TfL, London bus mileage is expected to be flat over the next five years. While falling bus journeys do not immediately impact operator revenue (due to the nature of the contracts), over the medium term this raises the risk of reduced work-scope on renewal.

Strong competition raises risk of aggressive pricing, contract losses

Both GOG and SC cited rising competition as a key headwind given there are 10 operators in the London bus market. Meanwhile, bonus payments received by bus operators have declined dramatically over the past three years (Fig. 1). Amid lower bus demand and potential cuts to bus services, we believe aggressive pricing by operators remains a key risk.

Key takeaways from Go-Ahead’s FY17 results:

Go-Ahead reported its FY17 (June year-end) results last week. Key takeaways for the London Bus business from Go-Ahead’s results and conference call are as below:

• Sluggish growth in London bus operating profit: Overall, London bus operating profit increased 2.1% in FY17 y-y, with like-for-like revenue growth coming in at 1.5% (FY16: 4.4%). London bus mileage, though, declined by 1.7% in FY17 (FY16: +2.3%). This result, however, included results for the Singapore bus business, which started operations on 4 Sep, 2016.

• QIC bonus higher y-y but lower than historical: Despite the congestion issues, Quality Incentive Contract (QIC) bonuses rose y-y to GBP6.9mn in FY17 (FY16: GBP1.1mn) mainly as a result of easing congestion, as some of the road works came to an end. Management guided that QIC bonuses in FY18 will likely be maintained at a similar level.

• Competitive pressure in London bus remains high, resulting in loss of some contracts for Go-Ahead, and the company has guided slightly weaker performance in FY18F on a y-y basis.

• Multiple issues plaguing London bus operations: Congestion (due to ongoing road-works) remains a big problem in London, which is driving down passenger numbers. Additionally, pax and revenue growth also weakened towards end of FY17 due to slowdown in economy and poor employment growth.

Commentary from Stagecoach too remains bearish

Stagecoach, which is the fourth-largest operator in London (~13% market share by fleet size) and reported a 9% y-y drop in London bus operating profit in FY17 (year-end: April), expects FY18F operating profit from London Bus business to fall y-y due to 1) weak demand overall, 2) continue inflationary pressure relating to bus drivers, 3) heightened competition for London bus contracts given multiple players but weak demand outlook.

Given higher competition, management believe there remains risk of potential losses as contracts come up for renewal in FY18. Stagecoach management cited traffic congestion as a key challenge and believe congestion issues are impacting passenger volumes. The group also highlighted that passenger volume decline is faster in London vs regional operations (outside London)

Source: Nomura Research - 15 Sept 2017