Initiate With HOLD; Doing One Thing & Doing It Well…

• We initiate coverage of COMFORTDELGRO CORPORATION LTD (SGX:C52) with a HOLD and DCF-based (WACC 9%, LTG 1%) Target Price of SGD2.45. We believe its transport focus plus global expansion provides a decent shelter amid private-taxi-hailing competition. This has likely been priced into valuations of 17x 2019E-20E P/E.
• Share support should come from continued forecast payouts of 75% for prospective 4.3%-4.5% yields.
• Irrational taxi competition remains a risk to our outlook while additional contributions from acquisitions could provide upside.

…in as Many Places as Possible…

• In 2018, ComfortDelGro generated 59% of its revenues from Singapore and the rest from overseas versus 64% in 2016. Management aims to reverse this mix in the longer term. It will continue to invest in companies that permit majority control overseas, preferably with rate structures like those under Singapore’s bus-contracting model (BCM) that will be immediately earnings accretive. The UK and Australia fit this profile and already account for 88% of its overseas revenues.

… But Hail, Hail the Gang’s Not All Here, Yet!

• In the wake of heightened competition before Uber’s departure from Singapore, ComfortDelGro right-sized its taxi fleet to 12k. Competition from unlisted Grab and Go-Jek is not yet as fierce, as the two unicorns are evolving their businesses beyond ride-hailing and/or focussing on larger-population markets.
• Nonetheless, a 50bp reduction in taxi EBIT margins could hurt our 2019E core profits by 1% and Target Price by 1%. We already assume a -5% CAGR for taxi EBIT over 2018-21E.

Dividend Support

• Management remains open to acquisitions of up to SGD1b, which would translate to a gearing of just 24% vs current net cash.
• With or without such acquisitions, we believe ComfortDelGro can continue to support 75% dividend payouts and generate defensible yields. In the event there are no major acquisitions, we would not rule out the possibility of special cash dividends in the medium-term.

Corporate Information

• ComfortDelGro is one of the largest land-transport companies globally with a fleet of 43,300 buses, taxis and rental vehicles as at end-2018. It operates in seven countries: Singapore, Australia, the UK, China, Ireland, Vietnam and Malaysia.

Public transport: increasingly defensive

• Under public-transport services are its bus and rail businesses. Revenue is primarily derived from Singapore but overseas contributions have increased and may continue to increase as ComfortDelGro makes overseas acquisitions.
• In Singapore, its ownership of SBS Transit (SGX:S61) gives it a leading 60+% share of the scheduled bus market with around 3,400 buses. ComfortDelGro also operates four major rail systems through SBS Transit:
  1. the North East Line (NEL) with 16 stations covering 20km;
  2. Punggol light rail transit (LRT) with 14 stations;
  3. Sengkang LRT with 15 stations; and
  4. DTL with 34 stations spanning 42km. This includes DTL’s third stage, recently opened on 17 Oct 2018.
• With the conversion of Singapore’s bus-operating framework to BCM in Sep 2016, bus profitability and cash flows have improved. Cashflows should be less volatile due to BCM’s cost-pass-through mechanism and capex responsibility by the government. Meanwhile, ComfortDelGro invested some SGD479m in 2018, primarily in Australia’s bus industry which operates under a BCM-like regime. These investments already contributed to ComfortDelGro’s results last year and will make a full year impact this year.
• Rail operations do not fall under BCM and as such, are subject to market and fare volatility. In particular, its DTL operations have been hampered by ridership that falls below regulator LTA’s assumptions. The latter had formed the basis of ComfortDelGro’s bid for the line in 2014. With the Thomson East Line (TEL) already tendered out under BCM, future rail line operations that ComfortDelGro may bid for may also be subject to BCM’s more defensive earnings framework.

Taxi services: right-sized and going greener

• With control of the Comfort and CityCab brands and fleets, ComfortDelGro is Singapore’s leading taxi operator. It operated over 12,000 taxis as at end- 2018 for a 60% fleet market share. Comfort purchases vehicles and rents them out to self-employed cabbies.
• The period of intense competition in 2016 until Uber’s departure in 2018 led to industry right-sizing. ComfortDelGro’s fleet was reduced by a 10% CAGR over 2015-2018. Also indicative of the industry attrition during this period and subsequent recovery was a fall in taxi drivers’ vocational licences in 2017. Most were likely from drivers migrating to private car hiring by the ride-hailing companies but have again in 2018 grown close to previous levels.
• The entry of Go Jek with a beta launch and now full commercial launch present a new risk to the taxi industry. We note, however, that within a month of its commercial launch, Go Jek has reduced its driver incentives. It has emphasised growth in services beyond transport such as food delivery, digital payments, logistics and business-partner solutions.
• A recent doubling of Singapore’s diesel fuel tax to SGD0.20 / litre may precipitate taxi drivers’ attrition as cabs are largely fuelled by diesel. Cabbies may opt for petrol or hybrid private-hire companies as CDG has chosen to pass on the tax to its drivers. ComfortDelGro will, however, also pass through a SGD850 reduction in upfront diesel taxes for taxis to its cabbies to help offset their higher fuel costs. It has been refreshing its fleet with hybrid vehicles which amounted to an estimated 17% of its fleet as at end- 2018, up from just 1% in 2016. Even with diesel fleet renewal, emission standards levels of the vehicles is now majority on Euro 5 emission standards. This is even more so for its UK cab operations where all new vehicles will be hybrids or have Euro 6 standard engines.

Support services: smaller but higher-margin

• ComfortDelGro offers services that complement its core land-transport businesses. Also offered to external clients, they include automotive engineering, vehicle inspection, car-rental and bus-station operations. Mostly used by its taxi fleet and drivers, these services made up 10% of its 2018 revenues but a much higher 21% of EBIT. The reason is their higher margins, which partly reflect the scale of its core businesses.

Overseas expansion

• ComfortDelGro began its overseas thrust soon after its creation from a merger in 2003. Ever since, the UK, Ireland and Australia have grown to be its largest overseas revenue and EBIT contributors. In 2018, management executed SGD479m acquisitions, mostly to tap bus opportunities in Australia. Management continues to evaluate investments in countries and entities that can give it management control and operate under BCM-like models.

Investment Thesis

We like the business but valuations are fair

• We believe ComfortDelGro’s land-transport business is highly defensive against heightened competition in the taxi space. ComfortDelGro has ramped up its overseas transport businesses in favourable regulatory and market environments with its excess cash. As these have been consistently profitable, we forecast positive cashflow contributions and continued dividend payouts of 75%. Management has a minimum commitment of 50%.
• Current ComfortDelGro’s share price, however, likely has priced in its defensive businesses. At 17x 2019E P/E and a 2% core profit CAGR over 2018-21E, the stock trades near its 3-year and 5-year P/E averages of 16.4x and 17.6x. EV/EBITDA is also near its 3-year and 5-year averages.
• We have a DCF-based (WACC 9%, LTG 1%) Target Price of SGD2.45. Initiate coverage with a HOLD. Worse-than-expected taxi competition is a key risk to our outlook. M&As with significantly higher contributions could provide long-term upside albeit a short-term pressure on FCF.

Rock, paper, scissors

• The ongoing shift of bus and rail public transport in Singapore towards a BCM regime has yielded favourable results for ComfortDelGro. Although margins are lower, BCM removes market-demand risks and provides timely cost recovery. This provides a bedrock for ComfortDelGro’s earnings.
• While local and overseas bus revenues should continue to account for the bulk of our 6% transport-revenue CAGR forecast for 2018-21E and 4% total-revenue CAGR outlook, we think taxi revenues could dwindle by a 3% CAGR. Although we do not anticipate the same steep declines as in 2017 given right-sizing by ComfortDelGro and the industry since 2017, the latest entry of unlisted Go Jek is likely to have some ripple impact on Grab and ComfortDelGro. Even without escalation, we think the perception of increased competition could dampen sentiment on the stock.

But not as risky as before

• We believe the two ride-hailing unicorns are evolving their business models - and thus aggression - beyond the public-transport space and into larger-population markets such as Thailand, Indonesia and Philippines. For example, within a month of its commercial launch in Jan 2019, Go Jek has reduced its driver incentives and emphasised growth in other services.
• It thus seems unlikely that ComfortDelGro will see the same intensity of competition as during the height of attrition during the 3-way fight between the taxi industry, Grab and Uber in 2016-2017. A 50bp reduction in taxi EBIT margins could hurt our 2019E core profits by 1% and Target Price by 1%.

Valuation

DCF methodology

• We believe DCF is appropriate given the steady cashflows of the company and businesses. Cashflows should continue to improve with ComfortDelGro’s shift towards more public-transport subsidiaries globally that come with more visible BCM cashflow visibility.
• We apply a WACC of 9.0% which is ComfortDelGro’s cost of equity given the company’s net-cash position, barring major acquisitions or capex. We derive a Target Price of SGD2.45, assuming an LTG of 1%. If the stock trades to our Target Price, 2019E/20E P/E would be 17.3x/16.9x and EV/EBITDA, 6.2x and 6.2x. These are in line with their 5-year averages and at a slight premium to, though not 1SD above, their 3-year averages.
• If the company uses its entire SGD1b acquisition budget with a neutral impact on FCF, its resulting net gearing of 24% would bring WACC lower to 7.4% and Target Price higher to SGD2.99. Without a corresponding lift in EBIT, implied valuations would be over 1SD above their 3-year and 5-year P/E averages. It is thus critical that acquisitions be immediately EBIT- accretive. Management aims to acquire overseas companies that can immediately add to earnings.

Fair against historical valuations

• ComfortDelGro is trading near its P/E and EV/EBITDA averages, be it on a 3-, 5- or 10-year basis. We believe 3-year averages are particularly relevant as they capture the height of Singapore taxi competition in 2016 to early 2018 and respite after Uber’s exit. ComfortDelGro’s 1-year forward P/E dropped more than 1SD below mean to 14x (Fig 9) in FY17; so did its EV/EBITDA.
• Trading close its 3-year average dividend yield of 4.5%, it offers value against its 5- and 10-year averages of 3.9% and 3.8%, respectively. Again, we believe its 3-year average is more representative of the new norm after the advent of ride-hailing.
• Although Go Jek’s entry into Singapore has not been aggressive and ComfortDelGro & Grab have not attempted to squeeze it out, any escalation could potentially weaken ComfortDelGro’s share price and provide more attractive entry levels.

Returns metrics against regional peers

• There are no consensus forecasts available for the listed transport companies in Asia and hence we are unable to compare ComfortDelGro valuations against these. Against its peers above USD1b valuation its returns metrics whether ROIC, ROA or ROE compare favourably even after the intense period of competition in 2016-17. There is some returns dilution given the acquisitions made late in 2018 but full year contributions from these drive improvement anew.
• Although a completely different industry and asset class from ComfortDelGro, among the regulated business models we cover we like NetLink NBN Trust (SGX:CJLU) (Rating: BUY, Target Price: SGD0.93). NetLink NBN Trust’s exposure to regulated returns is higher than ComfortDelGro (over 90% of revenues vs ComfortDelGro at over 60%) and it also offers a higher dividend yield of 6% for FY19E.
• MKE vs consensus
• Our forecasts are slightly below FactSet consensus. Although our revenue forecasts for 2019E onwards are 2-4% higher, we incorporate dilution from lower-margin public-transport services. We also conservatively assume that taxi margins will contract by 100bps to the levels of 2017 competition. This is likely why our EBIT, core profits and Target Price are below consensus. Management has guided for overall revenue growth in 2019E but EBIT margin contraction due to taxi competition whereas consensus estimates imply a slight increase in margin.
• Our HOLD rating is non-consensus as Bloomberg currently has 13 BUYs, 3 HOLDs, and 1 SELLs.

Opportunities, risks and sensitivity analysis

• We see the clearest growth opportunities in acquisitions overseas or any future wins of Singapore rail lines under BCM. For now, we have not factored in new acquisitions and we doubt that consensus has either. Every 1% increase in public-transport revenue can raise our core profits by 1% and Target Price by 1%.
• With the Downtown MRT Line (DTL) still operating below ridership targets and under the old fare-based regime, public-transport EBIT margins have been suppressed to 8.0% in FY18. This has been made up by higher margins from overseas bus operations. We assume a 50bp margin improvement for 2019E. Every 50bp change could move our core profits by 4% over 2019E-21E and Target Price by 3%.
• We also assume a 5% decline in taxi revenues for 2019E and 100bp contraction in EBIT margins. A further 1% reduction in taxi revenues would reduce core profits by 0.3-0.5% over 2019E-21E and our Target Price by 0.4%. A 50bp further drop in taxi EBIT margins would affect core profits by 1% and Target Price by 0.6%.
• Assuming no acquisitions, our WACC is 9%, as the company would remain in a net-cash position. If it ever gears up or where LTG is greater than 1%, our Target Price sensitivity suggests premium-to-average-historical valuations, unless its new investments can make substantial contributions to earnings.

Financial Analyst & Forecasts

• ComfortDelGro’s bread-and-butter is its land-transport and supporting services. With its increased exposure to BCM public-transport services globally and locally, its earnings base should become more and more defensive. This makes it less susceptible to market forces as operating costs are compensated for in a timely fashion.
• On the other hand, its taxi and rail businesses remain subject to market risks. Its taxi business, in particular, has been hounded by perceived and actual threats by the privately-funded ride-hailing unicorns such as Grab and Go Jek.

The rock: public-transport services…

• We anticipate that revenue growth will stem from the full-year impact of its overseas bus expansion. Management has guided for increasing revenue contributions from Singapore and Australia public transport with stable contributions from the UK. Rail continues to be held back by DEL ridership in Singapore but we estimate a 6% revenue CAGR for bus and 8% CAGR for public transport over FY18-21E.

…paper: taxi vulnerabilities…

• The taxi division’s twists and turns after the entry of Uber and Grab in 2013 and an escalation of hostilities in 2017 were mirrored in ComfortDelGro’s share price. ComfortDelGro’s right-sizing of its fleet since 2016, Uber’s exit in 2018 and Go Jek’s mild entry this year have provided relief and a degree of stability for the division. However, we err on the side of caution and assume revenue pressure from the 3-horse race between ComfortDelGro, Grab and Go Jek. Our assumption of a revenue decline here is below guidance of stability for this year. We estimate that taxi revenues will decline by a 3% CAGR over 2018-21E, bringing down taxi EBIT by a 5% CAGR.

… and scissors: risk perception vs defensive earnings

• We believe climbing public-transport revenues and EBIT contributions will increasingly buttress the stock from earnings shocks. This is reflected in our group revenue and EBIT CAGR forecasts of 4% and 2% for 2018-21E, despite pressure on its taxi business. ComfortDelGro’s earnings and Target Price sensitivity (Fig 16) to the taxi business is no longer as significant, though taxi price wars may remain natural headline grabbers.
• Risk perception thus remains its greatest share-price hurdle. Based on its 3-year P/E band (Figs 9-10 in attached PDF report), ComfortDelGro’s share price can over-anticipate earnings risks, overshooting on the downside. We believe such opportunities could arise in the next 12 months. We may also revisit our rating if new, substantially-contributing acquisitions are made this year as we have not factored these in.

Balance sheet

• Even with its significant acquisitions last year, ComfortDelGro remained in a net-cash position. We anticipate status quo, barring no further acquisitions. Management is willing to spend up to SGD1b on new overseas acquisitions. This is a potential war chest rather a guaranteed amount to be utilized. Even if the entire amount were spent this year, net gearing would only rise to 24%: un-stretched. We assume no contributions to FCF yet but going by its 2018 acquisitions, we think management will continue to select outfits that can contribute to earnings immediately.
• Whether it goes on a full acquisition spree or not, we believe ComfortDelGro will continue to pay out more than 50% of its core earnings. We assume 75%, as has been the case in the past two years.

Source: Maybank Kim Eng Research - 03 Mar 2019