Description

SBS Transit (SBVV.SI) is a leading public transportation service provider in Singapore, whose prospects have been obscured by a combination of the Covid pandemic and gradual uptake of its latest metro line. Moreover, as a provider of critical transportation services, SBS has benefited from considerable government support during the pandemic. As mobility returns to normal, that support should dissipate, but in a Covid-worsening environment, it should remain. This state support offers an asymmetric operating profile, which I’ll argue should translate to an asymmetric return profile.

SBS has 3 main business lines:

Their oldest, core business is operating bus lines throughout Singapore. The economics of this business are very stable, due to an asset-light contracting model (“BCM”). The government purchases and maintains buses and depots, and establishes the bus routes and schedules. A handful of service providers bid in a competitive tender, but it is not pure cost competition, as the government places an emphasis on quality standards. These tenders are 5 to 7 years, and in practice are expected to be longer-lasting, as the incumbent is likely to win the tender if service quality is high. SBS has roughly 60% share in this market. While SBS faces some risk due to changes in its costs (heavily staff, but also fuel), the model results in essentially no revenue risk

The newer metro (MRT) segment, where the government designs and finances the rail infrastructure, while relying on a service provider to maintain and manage operations for roughly 20 year license periods. Unlike the bus line, SBS does face revenue risk, though the government absorbs some of the downside (as well as the upside) both in revenues and in EBIT margins. The rough result is that the partnership is targeting roughly 5% margins, which SBS has missed, first due to the ramp up in its newest line (the Downtown Line), and now due to reduced mobility in Covid. Each of these headwinds should abate, and in the coming years, we expect the Downtown line to be a meaningful contributor

Ad and lease revenue from buses, trains and depots. Unlike the transportation lines, we model this like a normal business, though obviously SBS benefits from its privileged position in the transportation infrastructure. In other words, we view this business line as a subsidy for the core transportation service provision.

SBS’s current market cap is 940M SGD, though only a quarter of it floats, with a large stake held by the taxi and transportation specialist ComfortDelGro (CDG). We think CDG is likelier to tender for the remaining shares than to monetize their stake, so on balance we consider the low float a positive as a potential catalyst (though not a likely one, despite the Chairman’s impending retirement). Despite considerable Covid headwinds, SBS earned $79M in 2020, and $83M LTM. 11x is pretty close to a trough multiple, though well above trough earnings -- due both to improved profitability in the MRT segment, as the Downtown line has expanded, and also to government wage support. 11x does not seem like the right multiple for a key service provider, whose essentiality has been demonstrated by the support is has received during adverse conditions

From a recovery standpoint, Singapore is in prime position:

79% of the entire population is fully vaccinated (much higher in the adult population)

The technocratic Singaporean government has already communicated a vision of “post-Covid”, that involves society living with Covid, rather than eradicating it completely. Although this is more message than reality at this point, it stands in stark contrast to how other Asia countries that have kept the virus tamped down have articulated their strategy. There will surely be further cycles of reduced mobility, but it seems clear the government does not intend to operate indefinitely in a sheltered state.

Mobility has already substantially recovered. Apple public transit routing requests ran at 40% of baseline in 2020, 85% in H1, and in recent days roughly 95%. These numbers appear to track the MRT ridership figures we see elsewhere relatively though well, though the MRT ridership appears to lag (eg H1, SBS’s lines ran 35% under pre-pandemic levels)

The secular backdrop is very favorable for SBS. As a space-constrained, island city-state, Singapore has placed and will continue to place large emphasis on socially accommodative policies, both in public housing and transportation. There is certainly some risk that hybrid and work-from-home developments will sap some of the commuting demand, but we consider this secondary to the secular tailwind of a growing population. To illustrate, you can look at the tax system (Additional Registration fee, Excise Duty, GST, Emission surcharge) that results in a Honda Accord selling for 175K SGD. The government is determined to limit the scope of vehicle expansion, with an economically-minded policy that serves to deter with incentives that capture the externality of congestion and emissions. Consistent with these, we see accommodating schemes that bolster transport providers like SBS.

As a core illustration of the structural support, the government runs a Fare Revenue Shortfall Sharing (FRSS) scheme, such that SBS carries all revenue risk >= -2% from their target, 50% of the revenue risk between -2% and -6%, and only 25% of the risk below -6%, with the government absorbing the balance. Additionally, there are profitability guardrails as well: the government absorbs 50% of any margin deficit below 3.5%, though it also receives roughly 90% of the margin excess above 5%. The impact on both the upside and downside is obvious, which matches the goals of the government. If nothing else, we think this suggests a somewhat higher multiple for SBS, as the government has demonstrated over time, through a variety of means, the desire to stabilize its key transportation providers. Another such mechanism at the government’s disposal is the fare increase scheme. Historically fares have grown roughly 350bps CAGR. The permitted fare increase from last year was unsurprisingly deferred, but we view this as another lever that the government can pull to adapt to any changes in transportation needs on the other side of the pandemic

The most visible, and likely temporary, support has come in the form of the Jobs Support Scheme (JSS), under which the government has supported employers that have retained staff during the pandemic. SBS benefited from $110M SGD in 2020, $34M SGD in H1 2021, and we project $16M SGD in H2, and model it disappearing thereafter. In reality, we expect this to be another counterbalancing force, where any period of significant reduction in mobility or economic activity will correlated with the government reinstating some form of the JSS. 

Ignoring pandemic dynamics, the key trend playing out for SBS was the gradual rollout and expansion of the Downtown Line, with the 3 previous expansions taking effect in Dec 2013, Dec 2015, and Oct 2017. We’d emphasize two forces at work here. One, there are discontinuous effects from each expansion, as new residential areas are drawn into the commuting funnel to the CBD. Two, and what we find most compelling, is the gradual adoption as the city reorganizes itself around the MRT network. The government has invested heavily in the Downtown Line for business commuting, and as is the case in any major city, large amplifying forces coalesce around the network effects and efficiencies that are produced from a public transportation network (think of the premium on apartments close to a subway station, but much stronger due to the government-influenced cost wedge). In short, there’s a long, steady adoption curve, as developers, families, and commuters adapt their behavior to the new infrastructure. We expect this to drive continued expansion for SBS. Keep in mind that while the upside from rail margins is somewhat capped, the opportunity from revenue expansion (with margin maintenance) is very real. We expect this to result in a 30% increase in operating income from 2019 levels by 2024.

The other dimension to emphasize is quality. SBS is a local, long-standing, trusted operator and employer. Their market share of 60% of the bus market gives them both credibility as a public partner, and also economies of scale in the staff and servicing channels. To illustrate how the government approaches the tender process, we find this 2018 Contract award instructive:

SBST was awarded the contract because its proposal demonstrated a comprehensive understanding of the operational considerations, and strong competence in bus service scheduling that would enable the optimal deployment of buses and resources. The proposal showcased SBST’s extensive experience in bus operations, while offering good value for money[4]. Furthermore, SBST prepared comprehensive contingency plans for cross-border services, and committed a significant number of experienced technicians to ensure high maintenance and reliability standards. SBST also demonstrated innovative IT solutions for infrastructure and asset maintenance, as well as security management, with the development of several in-house mobile applications for staff to report defects and incidents. In terms of manpower development, SBST presented a career development program to up-skill its staff, with more opportunities for career progression.

(source: https://www.lta.gov.sg/content/ltagov/en/newsroom/2018/2/2/lta-awards-bukit-merah-bus-package-to-sbs-transit-ltd.html)

And to bolster that point, the tender process is public, revealing that SBS had the 5th-lowest bid. The combination of excellence and incumbency helped SBS win the contract, and provides evidence against the bus tendering getting dragged into pure cost competition. Moreover, this should be an intuitive outcome, when considering the large positive externalities from the government’s perspective, who are far more concerned with a high-functioning public transportation network than they are with cost differentials

We don’t have a particularly high degree of precision in our valuation, but we have a fairly high degree of confidence that SBS is cheap. We project roughly $105M SGD in 2024 earnings in a fully-normalized and expanded Downtown Line setting, and $80M SGD in a bear case where we only return to 2018 levels of ridership and profitability. At current prices, the former translates to roughly 9x 2024 P/E, and the latter ~12x. For comparison, the HK metro operator (MTR Corp, 66.HK) trades at 22x 2019 earnings, despite essentially no earnings growth (2014 -> 2019 flat; whereas SBS earnings went from 13M to 81M), and despite MTR having much more material downside (SBS 2020 earnings were flat from 2019; MTR lost 5B HKD, after making 12B HKD in 2019). And while MTR is the most natural peer, it is not an outlier: BTS (Thailand’s mass transit servicer) trades at 22x pre-pandemic earnings, or 30x consensus 2024 earnings.

We think the primary reasons for the low valuation are:

Relatively under-covered, neglected asset. The float is roughly $175M, leaving it beneath the purview of many investors

The market has under-appreciated the transition from mediocre, capital-intensive infrastructure building business, to asset-light service provider. Meaning there is a historical anchor from capital intensity, that weighs on the multiple. Although results have steadily improved as a result of this transition, the multiple hasn’t. Over time, as cash continues to flow against mild capex, we think the multiple expansion should occur.

The lack of guidance (which we mostly attribute to conservatism) on the part of management with respect to the Downtown Line, has undersold the potential for further operating improvement

Risks:

The elephant in the room is Covid, and associated changes to work and mobility habits. While we don’t discount this risk entirely, we think it’s very unlikely that the core business model will be impaired, if for no better reason than the government is almost certain to restructure to an arrangement that is conducive to its key transportation partners

Somewhat more concerning to us is the potential for losing bus contracts. SBS has 3 routes up for renewal in 2023, and competitors have only 2. As aforementioned, we think SBS is well-positioned both competitively, and operationally. The only recent example of an incumbent losing a route was SMRT, who was both far from cost competitive, and also has developed a reputation for lower quality service. The bus contracting model has attracted competition, with Tower and Go-Ahead as new entrants. We think this risk is manageable, but we would not be surprised to see SBS lose a route in 2023, as the government aims to cultivate some of the new entrants

Catalyst

This is probably the most challenged part of the thesis. Covid recovery will almost certainly provide a leg upward, but we acknowledge that kind of investment thesis is abundantly available. That said, we think this idea is somewhat unique in its asymmetry, given how strongly results have held up even in the most adverse of conditions.

With the recent retirement of the chairman, there is some chance of consolidation with ComfortDelGro, which would likely occur at a 30-50% premium. 

Payout. 2021 dividends are going to total 4%, and we expect that to scale with performance go-forward, again as the anchor of capital-intensity has disappeared