SMRT rail reform may be imminent

Singapore

STRONG signals have emerged that the much-anticipated major rail reform involving SMRT Corp - which has been in talks with the government for over a year to sell its rail assets - is imminent.

If market wags are to be believed, the New Rail Financing Framework which will relieve the transport operator of excruciating capital expenditure (capex) burden and free up its cash flow could happen this financial year, contrary to analysts' general expectation for reforms in 2017 or beyond.

SMRT's stellar showing despite the street's negative take on the stock denotes a sooner-than-later expectation. Even though half of 12 analysts polled by Bloomberg have a "sell" call on the counter, SMRT stock has gained 18.5 Singapore cents or 14 per cent since October. This, despite the tough rail business - the firm's largest revenue contributor - that has hurt its bottom line.

Its rail operations suffered a third straight quarter of operating losses due to rising maintenance costs, with S$2.8 million bleeding in the quarter ended September. It has indicated that rail maintenance expenses, which include staff as well as repair and maintenance costs, could consume up to 50 per cent of rail revenue by year-end from 41 per cent currently.

Again, this gloomy backdrop starkly juxtaposes with its stock performance, which is up over 30 per cent off its August low of S$1.14.

DBS Research recently dismissed the price surge as the market being "overly optimistic" and "prematurely" pricing in the rail reforms - which the house does not expect to unfold soon, a view it has maintained for over a year.

While most analysts share that view, there is one notable contrarian: Deutsche Bank. In an end-October research note, it fanned expectations by indicating that the new rail framework is indeed close.

"Question on rail reforms should change from 'if' to 'when'," said Deutsche Bank, adding that doubts over the new framework have reduced considerably and it could be announced in the current financial year.

The house cites several reasons to back up its claims, chiefly consistent remarks from SMRT that talks with the government are progressing well and newly-appointed Transport Minister Khaw Boon Wan's public resolve to fix the frequent breakdowns. Moreover, Deutsche Bank suggests that it would make sense to push for the new plan before the Thomson-East Coast Line bid in 2016-17.

Under the new framework, Temasek-owned SMRT is expected to emerge as an asset-light company and a pure operator while the government would own all operating assets and the associated risks for major capital asset investments. These assets will then be leased to SMRT.

So far, SBS Transit's Downtown Line is the only contract that has moved to this framework after the government introduced the plan back in 2010.

SMRT's chief of three years, Desmond Kuek, has been eager to convert the firm's existing lines (the North-South East-West and Circle lines) to this new structure, to overcome the firm's key profit drag: its high capex burden.

At one point earlier, the talks with the government had appeared to have stalled given the complexity of the exercise but they have since been steadily progressing, if remarks by SMRT are anything to go by.

"For trains, we have made good progress after continuous and extensive engagement with the authorities in the past year," said SMRT chairman Koh Yong Guan in its latest annual report for the year ended March 2015.

Pushing the case further for a major shakeup in the sector is Kishore Mahbubani, dean of the Lee Kuan Yew School of Public Policy, who recently remarked that Singapore's public transport system should be de-privatised.

A discerning market watcher describes Prof Mahbubani's remarks on the faultlines of privatisation and his assessment that the rail breakdowns were due to profit-centric operators' relatively weak regard for maintenance works as a "trial balloon pitch" for reforms in the sector.

SMRT's stock has in the past surged on similar expectations - it did so back in April 2014 on news that Mr Kuek had submitted a detailed proposal to the government to sell its rail assets - but the rally eventually tapered off in the absence of visible progress.

Now, market speculation is once again heightened. Also, with the appointment of the new transport minister, word on the ground is that the rail reorganisation is being accelerated.

The spate of frequent breakdowns in the country's rail system of late also makes a compelling case for urgent changes to the current model.

Analysts expect an announcement on rail reform to be a clear catalyst for SMRT shares, which jumped 60 per cent last year following news of the bus reform - more so as rail makes up 55 per cent of group revenues, versus 20 per cent for bus.

"We see no reason why rail reforms should not materialise ultimately," said Deutsche Bank.